CHALLENGES AND OPPORTUNITIES OF INTEREST FREE BANKING SERVICES

(CASE STUDY OF CBE, HARAMAYA BRANCH)

A RESEARCH PAPER SUBMITTED TO DEPARTMENT OF ACCOUNTING AND FINANCE FOR

PARTIAL FULFILLMENT OF REQUIREMENT OF BACHELOR DEGREE (BA) IN ACCOUNTING
AND FINANCE

BY: CHALA DIRIBSA

ID: 2318/08
ADVISOR: GEMEDO.T (BA)

HARAMAYA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

JUNE,2018
HARAMAYA, ETHIOPIA

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AKNOWLEDGEMENT
First of all I would like to thank my Lord the king internal, immoral and invisible God for his
immeasurable continuous support for my success. Second, my great appreciation is to my
advisor Mr. GEMEDO.T to took time to give me valuable comments, suggestions and
corrections without which this senior essay would be meaningless. Next to this my great respect
is for my family for their financial and all facilities offerings for the research to be conducted.
Finally, I would like to bless my brother Firaol Mekonnen to serve me in technical and
professional assistances.

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ABSTRACT
The economic development of any country depends on the existence of well-organized financial
institutions. Financial institution refers to an establishment those focuses on leading with
financial transaction. Bank is a part of those institutions which accept deposit from economic
agents and then on lend this finds to make direct loans or invest in security, stocks and bonds.
Interest free banking derived from Islamic word, it is fundamental concept it operates primitive
professional and ethical investing while elimination of interest in all its forms is an important
future of the Islamic financial system, form of ethical investing and ethical lending except or that
no loans are possible unless they are interest free. The objective that establishment of interest
free banking is important for development of investment and saving to make positive
contribution to the fulfillment of socio-economic development of society. For sake of obtaining
sufficient data, the researcher used both primary and secondary data.

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Table of Contents
AKNOWLEDGEMENT..................................................................................................................i
ABSTRACT......................................................................................................................................ii
CHAPTER ONE..............................................................................................................................1
1. INTRODUCTION.......................................................................................................................1
1.1 Background of the organization.............................................................................................1
1.2 STATEMENT OF THE PROBLEM.....................................................................................3
1.3 OBJECTIVES OF THE STUDY...........................................................................................3
1.3.1 General objective..........................................................................................................3
1.3.2 Specific objectives..........................................................................................................3
1.4 SIGNIFICANCE OF THE STUDY......................................................................................4
1.5 SCOPE AND LIMITATION OF THE STUDY...................................................................4
1.6 ORGANIZATIONS OF MAIN PAPER...............................................................................5
CHAPTER TWO.............................................................................................................................6
2. LITERATURE REVIEW............................................................................................................6
2.1 Concept and Definition of Interest Rate................................................................................6
2.1.1 Interest rate.....................................................................................................................6
2.1.2 Structure of interest rate..................................................................................................6
2.1.3 Features of interest rate...................................................................................................7
2.2. Role of interest rate in financial system...............................................................................7
2.2.1 Asset pricing...................................................................................................................7
2.2.2 Motivates saving Habits.................................................................................................7
2.2.3 Helps for Investment decision......................................................................................7
2.2.4 Determine size of Loan...................................................................................................7
2.3. OVERVIEW OF BANK.......................................................................................................8
2.3.1 Banks and Interest Rates.................................................................................................9
2.4. AN OVER VIEW OF INTRESET FREE BANKING.........................................................9
2.5. EMERGENCE OF INTEREST FREE BANKS.................................................................11
2.6. FUNCTION OF INTEREST FREE BANK.......................................................................11
2.7. PRACTICAL EXPERIENCE OF SOME COUNTRIES...................................................12
2. 7.1. Pakistan......................................................................................................................12
2.7.2 Iran.............................................................................................................................12
2.7.3 South Africa...............................................................................................................13
2.7.4. Nigeria.........................................................................................................................13

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 2.8. RECENT TRENDS OF INTERST FREE BANKING......................................................14
2.9. Historical Development of Banking in Ethiopia................................................................14
CHAPTER THREE.......................................................................................................................16
3. RESEARCH METHODOLOGY..............................................................................................16
3.1 DESCRIPTION OF THE STUDY AREA..........................................................................16
3.2 SOURCES AND TYPES OF DATA..................................................................................16
3.3 METHOD OF DATA COLLECTION................................................................................16
3.4 TARGET POPULATION AND SAMPLING TECHNIQUE............................................16
3.4.1 TARGET POPULATION............................................................................................16
3.4.2 SAMPLING TECHNIQUE AND SAMPLING SIZE.................................................16
3.5 METHOD OF DATA ANALYSIS.....................................................................................17
CHAPTER FOUR.........................................................................................................................18
4. DATA PRESENTATION, INTERPRETATION AND ANALYSIS.......................................18
4.1 Demographic Characteristics of Respondents.....................................................................18
4.2 DATA ANALYSIS..........................................................................................................22
4.2.1 HABIT OF USING CONVENTIONAL BANKING SERVICE..............................22
4.2.2ABOUT THE PERCEPTION OF INTEREST BY THE RESPONDENTS.....................23
4.2.3ATTITUDEOF RESPONDENTS TOWARDS INTEREST FREEBANKING...........23
CHAPTER FIVE...........................................................................................................................24
5. SUMMERY, CONCLUSION AND RECOMMENDATION..................................................24
5.1. SUMMARY........................................................................................................................24
5.2 CONCLUSIONS.................................................................................................................24
5.3 RECOMMENDATIONS.....................................................................................................25
REFERENCES...............................................................................................................................26
APPENDIX....................................................................................................................................27

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List of Tables
Table 1: Educational Level of Respondents…………………………………………………………………………………………………..18

Table:2 Source: questionnaire.....................................................................................................................................................19

Table 3: Questionnaires about interest and interest free banking………………………………………………………………………..20

Table 4: Source: Questionnaire…………………………………………………………………………………………………………….21

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CHAPTER ONE

1. INTRODUCTION
The economic development of any country depends on the existences of well-organized financial
institutions. Financial institution refers to an establishment dealing with financial transaction
(www.envestopedia.com). Bank is a part of financial institution which accept deposit from economic
agents (liability to them) and then lend this funds to make direct loans or invest in securities, stocks and
bonds (Cambel Harvey,2010). Banks operate by charging interests as well as operate without interests.
Interest has become part of financial institutions (business.dictionary.com). Interest is fee a paid for use
party money to the borrower. It is the cost of renting money to the lender; it is income for lending the
money or the fee charged by a lender to the borrower for the use of borrowed money. In contrast the
above description, a bank operates without charging interests which means interest free bank. Interest free
bank derived from Islamic word; it is fundamental concept. It operates primitive professional and ethical
investing while elimination of interest in all its forms is an important future of the Islamic financial
system; form of ethical investing or ethical lending except that no loans are possible unless they are
interest free. (Ibrahim warder)

These banks started to establish their centers in the major cities of the world; they operate based on profit
and loss sharing by performing such partnership and then forming important economic function. They
combined the three important factors of production namely: capital, labor and entrepreneurship lastly
share accordance with rules and

regulations. In this case, interest is prohibited because interest is treated as excesses or increase. The
objective for establishment of interest free banking is its importance for development of investment and
saving so as to make positive contribution to the fulfillment of socio economic objectives of the society in
all aspects including trade, industry and agriculture.

1.1 Background of the organization

The former commercial bank of Ethiopia was the state bank of Ethiopia which received its
charter by decree on Nov.30.1943 in Addis Ababa. The bank was established with capital of one
million Maria Theresa Dollar (http://www.combanketh.et)
The bank acted as the country’s central bank with power of issuing bank notes and paper money
on behalf of the ministry of finance (http://www.combanketh.et)

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In May 1945, the bank was granted the sole right of issuing currency and after the legal
proclamation of 1945, an issue department was established in July of that year
(http://www.combanketh.et)
Later in July 1949, the bank was made the sole authority to deal in foreign exchange. The bank
was also engaged in wide range of commercial activities, and introduced saving accounts in
January 1946. (http://www.combanketc.etc)
The state bank of Ethiopia during its two decades of existence opened 21 branches in country, as
well as branch office in Khartoum and Djibouti. It started operations with a staff of only about 40
persons, but this had grown twenty years later to little short of monetary sectors
(http://www.combanketh.et)
During these periods, the bank played dominant role in the industrial credit and business finance,
and had significantly assisted the growth of industry and extension of monetary sector
(http://www.combanketh.et)
Up on the declaration of the new banking proclamation issued on July 23 of 1963, all previous
regulation which governed the banking and monetary sector were replaced and consequently the
function of central and commercial banking separately (http://www.combanketh.et)
Accordingly the split of the previous state bank of Ethiopia in to National Bank of Ethiopia and
Commercial Bank of Ethiopia new chapter in the history of commercial bank of Ethiopia
(http://www.combanketh.et)
The bank has started to deploy banking technology recently. ATM (Automated Teller Machine)
has been installed in Addis Ababa and some city branches have been committed in on line
banking. Commercial bank of Ethiopia annual report for the 2011 shows that total assets of 86.5
billon birr. It has about 547 branches (2011)(http://enwikipedia).
At present board of management and five executive managements authorize the bank. The
number of workers has reached over thirteen thousand (from manager of the bank)
Commercial bank of Ethiopia extended its branch to many district of the country. Commercial
bank of Ethiopia Haramaya branch is one of branches established in different areas. (from
manager of the organization). Commercial bank of Ethiopia Haramaya branch was established in
1972 with few employees and limited amount of capital. At the present time branch has about 30
employees. It has been performing according to the rules and regulations delegated to it from the
central bank. The services given by the branch is rendering demand deposit, saving deposit,

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VISA branded debit card, credit services, trade services which facilitate international trade, local
transfer and foreign exchange service including western union planer transfer, and other in bond
and out bond foreign services (Manual of the organization)

1.2 STATEMENT OF THE PROBLEM

The low level of investment in developing countries largely attributed to the low level of saving (Rodney
Wilson,1986). It is unquestionable that investment plays a leading role for the growth of a countries
economy, but this requires the accumulation of capital and appropriate allocation of accumulated capital.
There are religious as well as economic reasons, which have contributed to the emergence of interest free
banking as an alternative to its interest charged banking system in counterpart. It is the prohibition of
interest which is believed to be religious reason. The basic intention behind establishing interest free bank
to the desire of Muslim is to recognize their financial activity in a way that do not contradict the principle
of Islamic rule and enable them to conduct their financial transaction without connection in to interest
payment and received.

The economic reason derived from avers of principles providing inspiration to device an interest free
financial system has been substantiated in the way that interest concentrates wealth in the hands of few.
Thus, interest free banking emergence will predict positive contribution to both religious as well as
economic factors (Mohammed Taqi Usman Karachi, 1996).

This study attempts to use the recent data, increase the number of variables and people from various
segments of the society in order to access the need of interest free banking establishment in Ethiopia
particularly in Haramaya town.

1.3 OBJECTIVES OF THE STUDY

1.3.1 General objective

The main objective of the paper is to examine the opportunities and challenges of the
establishment of interest free banking services in Ethiopia particularly in Haramaya town.

1.3.2 Specific objectives

The specific objectives of this study are: -
 To show the possibility to establish a financial institution for those who do not involve in
the interest charged banking system.

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  To argue banking without interest is practicable and has potential to solve the problem of
capital trap in the country.
 To address services that can be rendered by interest free bank

 To provide valuable recommendation based on the finding of study.

RESEARCH QUESTIONS
 Does the society in Haramaya town need for the establishment of interest free banking
service?
 Is there awareness by government bodies about the contribution of interest free banking?
 Does the establishment of this service motivate the society for saving and investment?
 What is/are the role of interest free banking service for the society of Haramaya town and
surrounding area?

1.4 SIGNIFICANCE OF THE STUDY

This study would be relevant to business organizations and individuals to high light about the
need for the establishment of interest free banking, especially, to those who does not involve in
interest charged banking system. It may also give general understanding about interest free
banking to success for achieving its goal. This study may serve as a reference for future research
on the title. In addition to the above explanation, the results found from the study can be one
input for banks that are interested to involve in interest free banking system.

1.5 SCOPE AND LIMITATION OF THE STUDY

This study was conducted in Haramaya town. The research paper includes the experience of
establishment of interest free banking along with other issues. This research would focus on the
establishment of interest free bank and deals with issues about interest free banking. The
researcher is faced with problems of availability of sufficient data. In addition to this, problem of
corporation from concerned group of peoples and institution. Major limiting factors of the study
are lack of sufficient data and failure of respondents to return questionnaires. The researcher has
tried his best to overcome this problem and related challenges.

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1.6 ORGANIZATIONS OF MAIN PAPER
This paper is organized in to five chapters: Chapter one contains general introduction, statement
of problem, objective of the study, research question, significance of the study, organization of
paper, scope and limitation of the study. Reviews of related literature collected from different
sources are presented in Chapter two. Chapter three embraces description of the study area,
source and types of data, method of data collection, target population and sampling method,
method of data analysis.Chapter for deals with data presentation, interpretation and analysis. The
last chapter contains conclusions and recommendations about the overall study and findings.

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CHAPTER TWO

2. LITERATURE REVIEW

2.1 Concept and Definition of Interest Rate

Interest rate is a rate which is charged or paid for the use of money. An interest rate is often
expressed as annual percentages of the principal. It is calculated by dividing the amount of
interest by the amount of principal. Interest rate is often charged having a result of inflation and
Federal Reserve board policies (Campbell Harvey, 2012). For example; if a lender charges a
costumer birr 100 in a year on a loan of birr 1000, the interest rate would be (100/1000× 100=
0.1%). From the customer perspective, the interest rate is expressed as annual percentage yield
(APY). For example, from saving account or certificates of deposit when the interest is paid. For
others as credit card, mortgage and loan the interest rate is expressed as annual percentage rate
(APR).

2.1.1 Interest rate

Investor can earn interest by lending currency. Interest parity suggests that the rate at which
currency A can be exchanged by currency B related to the rate established today that can be
earned in the countries A and B. It applies a currency trade that occurs in the future (Campbell
Harvey 2012). The spot rate is the rate at which currency is exchanged today (By Linda Brewton,
Eshowe contributor). Forward rate is the rate established today that applies to a currency trade
that will in the future.

2.1.2 Structure of interest rate

What is the structure of interest rate? The term structure of interest rate is the relationship
between bonds and different terms or structure of interest rate on bond of different maturities
usually depicted in the form of a graph often called a yield curve (Campbell Harvey 2012).
Interest rate is directly correlated to the performance of the world economy. Government
officials craft monetary policy to manage national economies by influencing the banking system.
At micro level, investors and private consumers should have some appreciation for the
connection between interest rates and the economy before making financial decisions.

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2.1.3 Features of interest rate
Interest rates are the cost of money; lenders that offer capital for investment are compensated
with interest payment from borrowers. Interest rate measures risk, lenders demand and additional
compensation for lending to riskier to earn a primitive that is higher than the rate of inflation to
make any transaction worth while.US Treasury bill, which can be seen as risk free investments
are a bench mark for evaluating interest rate.

2.2. Role of interest rate in financial system

Economic development is partially dependent on the financial system to help mediate the
transfer of money to areas of the economy that need most (Rodney Wilson 1986). The financial
system has a number of key functions which help to facilitate this shift in money that are
important for sustainable developments.

2.2.1 Asset pricing

Interest rate helps to establish asset price in the free market economy. Perspective home buyers
often will refuse to buy a new home because of a high interest rates; housing prices then must
fall to attract buyers. Additionally, high interest rates attract investors to the safety of interest
bearing bonds at the expense of risked common stock ownership (Campbell Harvey, 2010).

2.2.2 Motivates saving Habits

The financial system allows placing your excesses money in to saving account in bank of your
choice. Keeping your money, safe guards your saving, and the bank pays you interest based on
the amount you keep in your account.

2.2.3 Helps for Investment decision

Financial system also facilitates transfer of money from investors to business when business;
raise capital, and the sale of stocks to investors. Investors give their money to the company in
exchange ownership in the company (Reilly brown 2005)

2.2.4 Determine size of Loan

Money in deposit account like saving account is used to provide loan for a wide range of project
to people and business. Mortgages, car and student loans are financed largely by deposit in

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banks, saving institutions and credit union. Generally, to facilitate the development of financial
system, the role of interest in the financial system is crucial in order to attain.

2.3. OVERVIEW OF BANK

Etiologically, the term bank is said have been derived from the term “ban co” some attributes the
origin of word “bank” to “banc us” or “banc”. All these terms however, mean a bench up on
which the medieval European money lenders or money changers used to carry on their monitory
transaction. The derivation, however, give the one the impression that banking in Europe was
started during the middle ages. But, the origin of banking is much more antiquated and no
defined dates of its origin can be determined. To define a bank is not an easy task. There are so
many definitions that one feels lost in them and the curiosity of the reader is turned in to
confusion.

The term “bank” or “banking” is generally used in very broad sense including the capitalist, the
financiers, the stock broker, the banking corporation and what not the oxford English dictionary
defines a “bank” as “an establishment for the custody of money received from or on the behalf of
the customers. Its essential duty is to pay their draft on it, its profit arouses from the use of the
money left on employed by them”. This definition, too, is not satisfactory; because, it does not
lay down the fundamental principles of working of a bank.

According to Kindly Shiraz “A bank is a person, firm or company having a place of business,
where credits are opened by deposit or collection of money or currency or where money
advanced or loan”. This definition brings somewhat nearer to the actual meaning of banking
institution and also explain various function performed by banks. But, certainly and undoubtedly
the definition given by Horace White, “A manufacturer of credit and machine for facilitating
exchange”, is short cut precise. Banks have different organizational set up. The organizational set
up is different in different countries.

From the organizational point of view, various bank divided in to:

1 branch banking
2 unit banking

From the ownership point of view these banks also have classified in to:

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 1. chain banking
2. group banking

From the point of view lending practice bank have been further divided in to:

1. pure banking
2. mixed banking

Also different function of bank, some of these are:

1. as borrower
2. as lender
3. as agency
4. service function
5. Creation of credit and etc. (TN Hajela, 2010).

2.3.1 Banks and Interest Rates

Bank plays vital role in the development of an economy; it is rather its integral part. It is a
special type of organization where the credit and capital are supplied (Reilly brown, 2005). Such
a market people deal in short term loans; the price at which the money is bought and sold is
called rate of interest. It is extremely helpful in establishing the price by which facilitating the
transfer of capital and floating funds from time to time and place to place according to demand
and supply.

The demands for such funds arise from business men and government for their various
operations. The supply comes from the bank which obtains it from people in the form of deposit.
In consideration of banks as money market to be tight when the supply of money fails short of
the demand, the interest rate fails. Such bank wish to holding of cash increased (Abdullah Sayid).

2.4. AN OVER VIEW OF INTRESET FREE BANKING

Over the last forty years, there has been a rapid expansion of financial institution that can be
characterized as interest free banking in that they do not deal in reset transaction. Interest free
banking, the more general terms, is expected not to avoid transaction based on interest but also to
participate activity in achieving the goals and objectives of financial system. (Rodney brown,

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2005). Financial dealing in compliance with Sharia law date back the early century of Islam, but
this traditional money lending and money changing rather than commercial banking as practiced
today. Modern commercial banking introduced in the majority of Muslim country with the
spread of European trade during the 19thcentury (http//www.finance in islam.com).

It was only in the 1960 that series consideration given to how modern commercial banking
could be adopted so that interest could be avoided. When enlarger an Egyptian doctorial student
was at university in Germany, he was impressed by the operation of mutual saving and loan
association. He thought that local saving bank could be organized, in Egypt in similar fashion
with saving being pooled and distributed to members in need of funds if a group of Muslims
saver could follow this practice there could be need for interest. While him return to country
Egypt, heaped and managed as well as a small saving bank in 1963 in the town of mitrghams a
town 18 km from Cairo in the Nile delta. The venture was very successful in harnessing funds
from land owners and small traders who had still know not used banks as they were devote
Muslims who were concerned about any dealing involving interest.

Within three years, more than 60000 Muslims had deposit within the bank in the 1967; there
were 19 banks in operation including those in Cairo with more than 250000 deposit and totals of
1.8 million Egyptian pound deposits. This bank neither paid nor charged interest; they made
profit for their depositors sometimes by financing business in profit sharing basis, but mostly by
engaging with trade and industry directly or in participation with others. They were barred from
changing paying interest although their character made no reference to Islam or Sharia (N.S.
daqqi,1986). The people not conversant with the principle of Sharia and economic vise without
return. Financial philosophy sometimes believes that abolishing interest from bank and financial
institution would make them charitable rather than commercial, concern which offer financial
service without return.

It is obvious that exclusion of interest from financial activities does not necessarily mean that
financier cannot earn a profit. If financing is mean for a commercial purpose, it can be based on a
concept of profit and loss sharing for which partnership and profit sharing have been designed
since the very inception of the Islamic commercial law. There are, however some sectors
financing on the basis of partnership and profit sharing that is not workable or feasible for one

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reason or another. For such sector the contemporary scholars suggested some other instrument
which can be used for the purpose of financing.

The present book is revised collection of different articles that aimed at providing basic about the
principles and percepts of Islamic finance with special reference to the mode of financing used
by the Islamic banks and non-banking financial institutions. The study would try to explain basic
concept underlining this instruments the necessary requirement for their acceptability from the
Sharia stand point and the correct method of their application. Study will also deal with the
practical issues involved this humble effort, expect to facilitate and understands difference the
basic principles of Islamic finance and the main points of difference between interests charged
banking and interest free banking.

2.5. EMERGENCE OF INTEREST FREE BANKS

The second half of 20th century witnessed a distinctly separate line of thinking on banking. This
was institutionalized at end of 3rd quarter and subsequently immerged as a new system of
banking called interest free banking based on profit and loss sharing banking. The world is now
experiencing operation of as many as 250 interest free banks and financial institution in more
than 50 Muslim and non-Muslim countries (Elaina Housby2011). There are economic and
religious reasons, which have contributed to the emergence of private limited banking as an
alternative to its interest charged counterpart.

The economic reason derived from providing inspiration to devise an interest free financial
system has been substantiated in the way that interest concentrates wealth in the hands of few. It
is the prohibition of interest which traced to religious reason. The basic intention behind
establishing interest free bank was desire of Muslim to recognize their financial activity in an
away that do not contradict the principle of Islamic law and enable them to conduct their
financial transaction without connection into interest. Thus interest free banking emerged as a
response to both economic and religious factor (Mohammed Taqi Usman Karachi, 1996).

2.6. FUNCTION OF INTEREST FREE BANK

An interest free banking is a financial institution with the function to implement and materialized
the economic and financial principles in the banking arena. The function of interest free bank is
not only to earn profit but to do well and bring welfare to people up holds the concept that

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money, income and property belongs to wealth is to be used for the good of the society. Interest
free bank operate principle of profit and loss sharing and approved modes of investment. It
strictly avoids interest which is the root all exploitation and these responsible for large scale
inflation and unemployment; some functions are:

 It promotes risk share between providers of capital and the user of fund.
 It also aims as maximizing profit but subject interest free modes
 In modern interest free bank to be tax collection and they also payout their tax.
 Since the share of profit and loss, the interest free bank pays greater attention to
developing project appraisal and evaluations.
Generally, the function of the interest free banking is committed to do away with disparity and
establish justices in the economy, trade, commerce, industry and also build socio economic
infrastructure and create employment opportunities (http//www.finance. slam.com).

2.7. PRACTICAL EXPERIENCE OF SOME COUNTRIES

2. 7.1. Pakistan
Pakistan adopted a policy of gradual transformation of its banking system from February 1979,
after several years of study and preparation by the government appointed council of ideology.
The process started when the president of Pakistan announced that interest was to be removed
from the economy with in period of 3 years. Three of specialized credit institutions are the house
building corporations, national investment trust and mutual trust funds of Investment
Corporation of Pakistan where to remove interest from their financing operation immediately.

In June 1984 the government announced discontinuation of dual window of operation on the
banking and financial system, except the foreign currency deposit which continue to earn fixed
interest, where brought under non interest based modes of financing.

Interest free banking in Pakistan appears to be cross road and if there to be further progress the
regulatory and legal condition must be such that system will have a fair chance to perform as
expected (http//www.financeinislam, com).

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2.7.2 Iran

The processes of transformation of interest free banking in Iran have proceeded in the three
distinct phase. Nationalization, restructuring and re-organization of entire banking system
characterized phase one taking place between 1979 and 1982.External and internal developments
did not allow the policy makers to develop coherent plan for interest free banking system
although various piecemeal attempts were made towards this objective.

The second phase began in 1986;it was a phase primary characterized by adoption of legislative
and administrative steps in order to implement a clear articulated model of interest free banking
The third phase which continue until now, began in 1996.This phase define the roll of interest
free banking system differently from the earlier phases .The banking sector has been used as an
instrument to restrict Iranian economy; the restriction was essentially direct the shifting financial
resources from services and consumption to the production sector in four ways.

First credit to the service sector. Second, it creates incentive for the development of cooperative
sector planning agriculture, industry and trade. Third, the banking system in partnership with the
government under takes to finance large industrial project and investment in social overhead
capital. Fourth, using all available model of finance to help farmers to improve and expand
production encourage growth of agriculture sector

2.7.3 South Africa

The Muslim population in South Africa is relatively small but both affluent and influential.
Interest free bank was introduced in South Africa in 1989 by Alabama Antioch bank operating
with a limited branch foot print. This only interest free offering until 2002 when first national
bank in the country launched an interest free finance product followed by an interest free cheque
account most recently interest free banking started offering its service compliant products
through its branch in Botswana in 2006. Absa the largest retail bank including group in south
Africa launched, the first comprehensive interest free offering this cheque account vehicle
finance, transactional saving account and interest free wills. This offering was supported by the
full range access support from the ATM and branch network in the country, as well as sale phone
andinternetbanking

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2.7.4. Nigeria

Nigeria with population of 140,000,000 people is not only the most populous country in Africa
but it is also the largest economy in west Africa. 60 percent of Nigerian Muslims and in response
to their demands to have a bank that meets their religious, moral and ethical aspirations the
efforts are in progress by a number of corporate bodies, individuals and Islamic organization to
achieve these goal and with their regulatory frame work of interest free banking by the central
bank of Nigeria in feb.2009; all is now set for jazz, the first interest free bank in Nigeria to
commence full commercial operation.

2.8. RECENT TRENDS OF INTERST FREE BANKING

In countries were interest free banking operating, its coverage and extent vary significantly from
situation where the sector is entirely Islamic (Iran and Sudan), to others were interest charged
and interest free system co-existed (Indonesia, Malaysia, Pakistan and United Arab Emirates)
and to countries were one or two interest free banks. The current trends seem to be toward
separation between interest free and with interest banks, while others have allowed interest
charged bank setup in windows open the way for some of the largest multinational banks to
participate. Even large interest charged banks in United States and Europe have opened interest
free banks as its operations.

2.9. Historical Development of Banking in Ethiopia

In Ethiopia, the history of Banking goes back to the year 1905 E.C, when the bank of Abyssinia
was established in Addis Ababa under the agreement made between emperor Minilik II and the
representative of the national bank of Egypt. However, this bank was liquidated in the year 1981
due to its in efficiency and poor profit oriented and was followed by the establishment of the first
indigenous Bank in Africa, bank of Ethiopia, which took over the commercial activity of the
former bank and on authorities to issue paper notes and coins.

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However, this bank itself was closed during the Italian invasion and many Italian banks such as
Bunco Di Roma, Bunco D’inapoli, Bunco national dellavouro and other were established in the
main towns of the country, after the end of the war. The state bank of Ethiopia was established in
1943 by the government of Ethiopia with a capital of 1 million Maria Theresa currencies; two
years later, the agricultural bank of Ethiopia and investment bank of Ethiopia were also
established to finance agricultural and industrial projects respectively.

The state Bank of Ethiopia had a sole right issuing currency under the legal tender proclamation
of the year 1945. In 1948 the same bank was given sole authority to deal in foreign currency and
foreign exchange transactions in the country. All commercial activities like current accounts,
issuance of drafts, mail and telegraphy transfers, opening of letters of credits, mobilization of
savings and granting loans were done by the same bank. This bank also introduced a system of
exchange control in 1949. Addis Ababa bank, Bunco D. ironman and Bunco Di’napoli were
merged and consolidated to form Addis bank SC January 1976; finally, in line with proclamation
no. 184 of August 2, 1980, the Addis Ababa bank and the former commercial bank of Ethiopia
were again merged to form a sole and monopolistic commercial bank in the country.

It was after this long history of banking in Ethiopia that only the national bank of Ethiopia and
three government owned banks, i.e. commercial bank of Ethiopia, the Agricultural and industrial
bank of Ethiopia and housing and saving bank prevailed before the economic reform of the
country with the coming in to being of the free market economy, ratios financial reforms have
been under taken to liberalize the financial sector. This marked the beginning of a new financial
sector in the nation. A year later the first private bank awash international bank went operational
in February, 1995(TnHajela, 2010). In Ethiopia, regards to interest free bank; the current
government is cautiously promoting the establishment of a home-grown interest free banking
industry. The idea is to authorize the first local interest free banking on the bases of only
Ethiopia.

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CHAPTER THREE

3. RESEARCH METHODOLOGY

3.1 DESCRIPTION OF THE STUDY AREA

This study will be conducted in Haramaya town, which is located in the Eastern part of Ethiopia.
Haramaya is the town found at the Eastward of Haramaya University which is about 526 kilo
meters far away from Addis Ababa.

3.2 SOURCES AND TYPES OF DATA

The researcher would use two types of data. These are primary and secondary data. The sources
for primary data are questionnaires and interviews from customers and employees of CBE,
Haramaya branch.

3.3 METHOD OF DATA COLLECTION

For this study, the data is collected from both primary and secondary types. The primary data
collection method includes questionnaires, personal interviews. On the other hand, secondary
data collection methods include: books, internet materials, published materials are employed.

3.4 TARGET POPULATION AND SAMPLING TECHNIQUE

3.4.1 TARGET POPULATION

The researcher collected data from customers and employees of CBE, Haramaya branch.
3.4.2 SAMPLING TECHNIQUE AND SAMPLING SIZE
The researcher will use non- probability purposive sampling for customers of CBE, Haramaya
branch and simple random sampling for employees of CBE, Haramaya branch. The total
population of CBE, Haramaya branch is 45 employees; since it is difficult to give questionnaires

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for all employees the researcher selects 15 employees by using simple random sampling
technique and 10 customers through purposive or judgmental samplings.

3.5 METHOD OF DATA ANALYSIS

The researcher will use descriptive method of data analysis to draw conclusions and inferences.
This descriptive type is proffered due professional using table; percentages are used to make
comparisons and interference

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 CHAPTER FOUR

4. DATA PRESENTATION, INTERPRETATION AND ANALYSIS

Chapter four presents and describes summery of data collected from the sample respondents
which is the sample of fifteen (15) respondents. The first section of the chapter describes about
demographic characteristics of respondents followed by interpretation about interest charged
banks and its service and about interest free banking.

4.1 Demographic Characteristics of Respondents

EDUCATIONAL RESPONDENTS
CHARACTERSTICS

Educational level NUMBER PERCENTAGE(%)

Illiterate 0 0

Primary education 0 0

High school complete 0 0

Certificate 2 13%

Diploma 1 7%

Degree and above 12 80%

TOTAL 15 100%
Table 1: Educational Level of Respondents

Source: Questionnaires. The above table clearly indicated that 12 respondents out of
15(80%)of respondents are degree and above degree, 2(13%) of respondents are certificate and
1(7%) are diploma respondents. Generally, from the indicated table 80% of respondents
completed their degree in order to facilitate and accurate service to the customer which means

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these employees are more skilled personnel and qualified professionals to offer the best service
for their customers.
Serial NO Questions Respondents
1 Currently do you use NUMBER PERCENTAGE
bank services
YES 15 100%
NO 0 0
TOTALS 15 100%
2 Why did you chose
CBE?
Location accessibility 5 33%

Variety of number of 8 53%

services
Absence of option 2 13%

TOTAL 15 100%

TABLE:2 Source: questionnaire

For question number two criteria for choosing commercial bank of Ethiopia from given
alternative 5(33%)of respondents answer due to location accessibility, 8(53%)of respondents due
to variety number of serves and 2(13%) respondent answer saying due to absence of option.
Therefore, customers preferred commercial banks mostly for variety of number of services

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N QUESTIONS RESPONDENTS
O NUMBERS PERCENTAGE
1.What type of interest free service do you currently receive from bank?
Deposit service 1 73%
Transfer and payment 3 20%
Loan service 0 0%
All of the above 1 7%
TOTALS 15 100
2.Do you have deposit or saving account?
YES 15 100%
NO 0 0
TOTALS 15 100%
3.If Yes why do you deposit or save?
For emergency or security 3 20%

For future consumption 10 67%

Table 3:

For earning interest income 2 13%

Total 15 100

Questionnaires about interest and interest free banking

N QUESTIONS RESPONDENTS
O
NUMBER PERCENTAGE

1 Have you ever taken loan from bank?

Yes 5 33%
NO 10 67%

TOTAL 15 100%
2 What is your opinion concerning interest?

3 Do you support if banking continues with interest free

lending borrowing?
YES 11 73%
NO 4 27%

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 4 In your view what is the benefit to establish interest free
banking?
Because it is prohibited to use interest in holy Quran? 9 60%
Because it have a role in economic development of 6 40%
Ethiopia?
TOTAL 15 100%
5 Do you think that establishment of interest free service
have any socio economic development(advantage)for the
society?
6 From those who use interest free service and from those
who does not use the service, which group do you think
larger?
Those who use interest free service. 7 47%
Those who does not use interest free service. 8 53%
Table 4: Source: Questionnaire

From the questionnaire the researcher identified that 5(33%) respondents took loan from
commercial bank of Ethiopia interest free service and 9(67%) respondents did not take loan from
banks. There are about 60% of Muslim respondents asked and answered their opinion regarding
interest as forbidden (haram) in holy Quran and also the respondents appreciate and supports the
interest free banking service for their socio- economic developments.
From the questioner the researcher recognized that about (60%) respondents would be
establishing interest free banking service for the sake of using interest is prohibited in the holy
Quran and about 6(40%) respondents were also benefits from interest free banking service for its
role in socio-economic development(advantage) of our country.
As we know the main motive of the commercial banks of Ethiopia is deposit mobilization. For
this reason, the opening of interest free banking service, commercial banks of Ethiopia get new
customer that do not comes ever. So the mobilized deposit has advantages in socio- economic
developments for our country.
Before the emergence of interest free banking service, a lot of peoples digging the grounds and
puts their money or accumulates in other un necessary place. Especially Muslim community
have misunderstanding and regarding banking industry as it does not concern them.

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4.2 DATA ANALYSIS
This analysis focuses on establishment and challenges of interest free banking service in
Haramaya town at commercial bank of Ethiopia. To make this analysis the researcher has
conducted questionnaires and interview to the concerned person i.e. to the different employees
and some other peoples when analyzing prospects of interest-free banking in Ethiopia in the case
of Haramaya town. This part of the study tries to analyze and address the questions through
which conducting a simple research survey aiming at assessing the possible response of sample
15 respondents with regard to their use of interest free banking service and look for their
outlooks for why they need to participate in interest-free banks since it established here.

4.2.1 HABIT OF USING CONVENTIONAL BANKING SERVICE

The questionnaire includes simple short interviews with respondents to enable for analysis of
some variable which are not included in the questionnaire or something looks vague for
respondents; therefore, almost all of them use bank services in one way or another. However
only few respondent answers that they did not step to the door of the bank.
With regard to the use of interest free charged banking service the majority of 8(53%) of
respondents responded as used banking service although there is no interest related service. when
they justify their reason for not to use of interest base in the money deposit amount, it is not
allowed by holy Quran.
Among the respondents who use interest charged bank service the major of them are use deposit
service 11(73%), transfer and payment services 3(20%), loan service 0(0%) and remaining
1(7%) use all of the above accounts.
From 15 respondents, there is no respondents who use use loan service from bank; the reason is
that the majority of them are prohibited in religious law. Interest receiving is not only prohibited
but also interest free loan services have socio- economic development by removing accumulation
of capital to individual owners. The respondents also say that we do not need deny Allah and his
prophet Mohammed through refusing to keep his commandments.

4.2.2ABOUT THE PERCEPTION OF INTEREST BY THE RESPONDENTS

With regard to use of interest, majority of respondents says that interest has very high problem.
The some of the respondents say that interest has so match exaggerated problem. From 15

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respondents only few participants explain that the interest has advantage for the development of
the country.
Generally, the researcher understood most of the respondents away from bank services, most of
the respondents fail to apply their project and most of the respondents see interest as very sinful
act that open war with religion.
Therefore, most of the productive money of societies is idle and it is not part of money
circulation. In another word the project ideas which can contribute for the development of our
country is not on work.
4.2.3ATTITUDEOFRESPONDENTS TOWARDS INTEREST
FREEBANKING
According the questionnaire gathered from respondents regarding to interest free bank and their
contribution, the willingness of many people is the encouragement of interest free service
established in Haramaya and in the country as general. With regard to know about interest free
banking the majority 90% respondents as have a fair understanding of its information and 10%
of the respondents write as there is no good knowledge about interest free banking.
The final question is about the respondents’ attitude towards their support and participation if
interest free banks are established over all banks founds in Haramaya town.
Accordingly, 85% of respondents are show strong need for participation and eager for its
establishment while 15% of them respond as it does not affect their current use of banks;
however, they have good aware of the interest free banking service.
Generally, the researcher understands that most of the society have fair knowledge about interest
free banking and majority of the society need to participate in establishment of interest free
banking service in Haramaya town.

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CHAPTER FIVE

5. SUMMERY, CONCLUSION AND RECOMMENDATION

5.1. SUMMARY
The sample of respondents shows a great interest for the establishment of an interest-free bank
with a believe that it can avoid problems which connected with the use of interest charged
banking. For instance, 60% of the respondents answer the existence of interest charged banking
makes them not to use the loan and interest charged deposit service account because of the bank
based its operation on interest.
The researcher assured this by 60% of the respondents puts the prohibition of interest for not
using the loan and deposit account respectively, which are in fact the most essential operations of
interest charged banking believed to take the country’s economy one step ahead, but without
accommodating such a huge part of the society an attempt of success with regarded to the
channeling of funds by using only the interest charged bank will be difficult.
There is no hope to take this people to the circle of serving with the interest charged banking
because 60% of them aware the great problem with the use of interest and turn their heads for a
better alternative.
The establishment and the desire of the community for participation in interest-free banks is
ascertained by 60% of the respondents and nobody is doubt about its necessity.

5.2 CONCLUSIONS
From the analysis the researcher concluded the gathered data. It is important to appreciate that,
the pre requisite for total establishment of interest-free banking in a country includes re-shaping
the society, re-structuring of the financial system and reforming of the laws according to the
dictates of religion. Unfortunately, the development of banking sector in Ethiopia is highly under
developed despite its establishment is old presence in the country.
The under development of the sector could easily be manifested by looking at its limited
outreach, discourage and its non-accommodative of all community in the country.
On the other hand, the overwhelming majority of the poor in the country are left behind the
access to bank service because of interest payment for the banks is quite high and their collateral

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requirement is unbearable to most and some of them not require to engage in interest affairs, the
poor who have been denied access of financial service usually, turn their hands towards informal
money lenders.
From playing their fair and legitimate share in their country’s development, this means that this
section of the society has been denied access to credit on religiously acceptable basis on
expansion of existing projects; therefore, it would be possible to conclude that the country has
lost a great opportunity of using the ample experience of this business oriented part of the society
who has the know-how and capacity to conduct business because of inefficiency of financial
institutions who failed to provide it with religiously acceptable way.

5.3 RECOMMENDATIONS
In Ethiopia, there are many private and public banks and expand in to different part of the
country to provide satisfied services for the society. These banks did not concern some group of
the society who do not need interest base banking activity service. Since large amount of those
societies money is ideal because of away from interest the researcher recommends as follows.
 In addition to the existing interest free deposit and checking account currently given by
commercial bank, the government should establish interest free bank in different cities of
the country, including Haramaya town administration.
 National Bank should make detail study on this alternative banking service to the
establishment of interest free banking services
 The society should participate in formation of corporation for the establishment of
interest free bank.
 The policy of National Bank should consider the society perception.
 Since establishment of interest free bank is one part of investment which contribute to the
development of the country, government should appreciate and create awareness in the
society to establish interest free bank.

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REFERENCES

 Ibrahim Warde (2010) 2ndedition, Islamic finance in global economy, Edinburgh universitypress
 Elaine Housby,(2011) Islamic financial services in UK, Edinburgh University press
 Abdullah Saeed (1999) Islamic Banking and Interest.
 Cambel Harvey (2010)
 MohamadTaqiUsmani Karachi (1996) Islamic Banking

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APPENDIX
HARAMAYA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
The purpose of the questionnaire is to collect primary data for conducting a study on challenges and
opportunities of interest free banking service.
INSTRUCTION: Put thick marks in the appropriate box for questions.
1. Sex male Female

2 Age 18 –20 21—26 26—30 31—38 39-45

3. Educational level
grade 10—12 diploma certificate degree >degree

4.Years of service 1 year 2 years 2--5 years > 5 years no service

5. Currently do you use bank services?
Yes No
6. Based on your judgment what are the criteria for choosing CBE?
Locational accessibility
Variety of number of services
Absence of option
7. What type of interest free service do you receive from bank?
Deposit service Transfer and payment
loan service
8.Do you have deposit or saving account?
Yes No
9. If yes why do you deposit or save?
For emergency
For future consumption
For earning interest income
10. Have you ever taken loan from bank?
Yes No

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11. Does the society in Haramaya town need the establishment of interest free banking?
Yes No
12. Does the establishment of this service motivate the society for saving and investment?
Yes No
13. What do you think the role of interest free service for the society around Haramaya?
It has significant role to improve the life of the society
It has no any role to improve the life of the society
14. What’s your opinion concerning interest?
Interest free banking is for the profit of the people
Interest free banking is for the profit of the government
It is neither for the profit of the people nor for the profit of the government
It is either for the profit of the people or for the profit the of the government
15 Do you support if banking is continuing with interest free lending and borrowing?
Yes No
16. In your view, what is the benefit to establish interest free banking?
Because it is prohibited in holy Quran
Because it has a role in economic development
Other reasons
17. Do you think that the establishment of interest free banking have any socio economic development
(advantage)for the society?
Yes No
18. From those who use interest free service and from those who does not use this service which group do you
think larger?
Those who use the service
Those who do not use the service
19. Explain the reason you think on question 19?
Many customers do not need the profit from bank

Many customers want to use the profit from interest banking

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