ODA BISIL COLLEGE AMBO CAMPUS

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE
OPPORTUNITIES AND CHALLENGES OF INTEREST FREE BANKING: IN CASE
OF COMMERCIAL BANK OF ETHIOPIA (KETERO BRANCH)
A RESEARCH PROPOSAL SUBMMITED TO THE DEPARTMENT OF
ACCOUNTING AND FINANCE IN PARTIAL FULFILMENT OF BA DEGREE IN
ACCOUNTING AND FINANCE

ADVISOR: Mr. GAROMA BEKELE

February, 2024
AMBO, ETHIOPIA.

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 Prepared By..

Name of Students IDNO

1, CHALA GELANA.....................................................................................092/13
2, BEDASA EJERSA....................................................................................089/13
3, BIQILTU FUFA.........................................................................................291/13
4, BONTU GETACHO..................................................................................090/13
5, BUZUNSH ETHICHA..............................................................................091/13
6, MULU NADASA.......................................................................................107/13
7, IDOSA ASAFA.........................................................................................323/13
8, KUME DIRIRSA .......................................................................................103/13

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Table of Contents
ACRONYMES....................................................................................................................................i
CHAPTER ONE........................................................................................................................................1
1. INTRODUCTION.................................................................................................................................1
1.1. Background of the Study............................................................................................................1
1.2. Statement of the Problem........................................................................................................2
1.3. Research questions:....................................................................................................................3
1.4. Objective of the Study................................................................................................................3
1.4.1. General Objectives...............................................................................................................3
1.4.2. Specific objectives................................................................................................................3
1.5. Significance of the study.............................................................................................................4
1.6. Scope of the study......................................................................................................................4
1.7. Limitation of the study................................................................................................................4
1.8. Organization of the paper...........................................................................................................4
CHAPTER TWO.......................................................................................................................................5
2. LITERATURE REVIEW..........................................................................................................................5
2.1. Introduction to Islamic Banking..................................................................................................5
2.2. Principles of Islamic banking.......................................................................................................6
2.3. Prohibition of Interest................................................................................................................6
2.4. Fundamental of Islamic banking.................................................................................................7
2.5. Compatibility of Islamic banking with conventional banking......................................................8
2.6. Status of Islamic banking in Ethiopia..........................................................................................9
2.7. Challenges of Islamic banking......................................................................................................9
CHAPTER THREE..................................................................................................................................13
3. RESEARCH METHODOLGY................................................................................................................13
3.1. Research design........................................................................................................................13
3.2. Source of data...........................................................................................................................13
3.3. Methods of data collection.......................................................................................................13

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 3.3.1. Types of data.....................................................................................................................13
3.3.2. Procedure for data collection............................................................................................13
3.4. sampling size and sampling technique......................................................................................14

4. Work Plan and Budget Schedule.................................................................................14

4.1. Work Plan...................................................................................................................14

4.2. Budget Schedule........................................................................................................15

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 ACRONYMES
CBE- COMMERCIALBANKOFETHIOPIA

IFB- INTEREST FREE BANKING

PLS- PROFIT AND LOSS SHARING

OIC- ORGANISATION OF ISLAMIC CONFRANCE

DC- DEBIT CARD

CD-CREDIT CARD

MFI-MICRO FINANCE INSTIUTION

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 CHAPTER ONE

1. INTRODUCTION
1.1. Background of the Study
Banks are the backbone of the economy of any country. It is the determinant factor to bring
the development of the country; it serves as a bridge in between savings and investment.
They are key financial intermediaries or institutions that serve as “middleman” in the transfer
of funds from savers to those who invest in real asset as house, equipment and factories. In
performing these function financial intermediaries improves the well beings of both saver and
investor by improving economic efficiency they raise living standards of the society. The
banking sector is considered to be an important source of financing for most business.
Commercial banks are the backbone of the economy of the country. In Ethiopia the finance
sector is one of the fastest developing sectors in the country with the establishment of new
commercial banks and micro-finance institutions. Nevertheless, this development and growth
is not horizontally (variety) rather it is vertically (in number with the same type of service).
The finance sector of the country is also coping VISA Debit Card and Credit Card in recent
years prove this fact. Commercial banks are still the dominant participant and contributor in
the finance sector of the country, though their insurance companies and micro-finance
institutions. However, in Ethiopia, the gap between rich and poor is still wide as in the other
underdeveloped countries. It will be due to injustice interest based activities of these
conventional banks (Mohsen & Muhammad, 1987). On the other hand, Islamic banking is in
a rapidly growing stage as a feasible alternative to conventional banking in world. Although
innovative solution for some issues are still lacking, it would be unfair to compare its
progress to that of establishing conventional finance. But Islamic banking puts a possible
solution for the problem of interest based banking (Siddiqi & Mohammed, 1969). Islamic
banking is based on two main financial principles. Firstly, investment is to be made in the
private sector through interest-free finance. Secondly, the development of financing
instrument is to be done in the basis of profit and loss sharing (PLS) as well as sharing of
risks. One major difference between Islamic banks and conventional banks is the prohibition
of interest on loans, given the fact that Islam does not allow unjustified capital increases, and
also it emphasizes on driving on capital increase through investment and going through full

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economic cycle (www.islamicbanking.com). One of the unique and salient character of
Islamic banks is that the integration of ethical and moral values with its banking operation.
Furthermore, Islamic banks eliminate the barrier between those who save and those who
invest and bring them closer to the real market. The nature of the finance intermediation of
the Islamic banks significantly differ from conventional banks and it is in harmony with real
market and developmental change in it (Abdul Ghafoor, 2010). Since October 28, 2013
commercial bank of Ethiopia is operating Interest Free Banking (IFB) by leaving window
units within the conventional banks in selected 23 branches (www.combanketh.et). This
study aimed to find out the opportunities and challenges face in CBE to implement interest
free banking.

1.2. Statement of the Problem

For the growing of investment and development of economy, finance sectors especially

banks, plays a significant role. Interest free banks are among these finance
sectors. Interest free banking seems to be of very recent origin. Now Islamic
banking is growing at an annual rate of 41 percent worldwide with asset of Islamic finance
institutions amounting to a staggering $ 700 billion last years (Abdul Ghafour, 2011). Many
international as well as local institutions have stepped into this Multi-billion dollars booming
industry. Interestingly Muslim and non-Muslim counties such as U.K, USA, Japan, China,
Sweden, Denmark and other European countries have been accepted and implemented the
Islamic banking system. Unlike the above mentioned countries, Ethiopia has only the
conventional banking system. Conventional banks intermediate funds from the depositors to
entrepreneurs on the basis of interest. Only these banks have dominated the Ethiopian finance
sector almost for centuries. Interest free banking on the other hand, is in a rapidly growing
stage as a feasible alternative to conventional banking in many countries. Nevertheless, the
opportunities and viability of interest-free banking is proven in other countries yet have not
started in Ethiopia. There might be various reasons for this. There will be potential challenge
and obstacles that curb the successful establishment and operation of Non-interest banking in
Ethiopia. Thus this paper is, conducted to assess the rationales behind the prohibition of
interest and signify possible opportunity of Interest free banking in Ethiopia. It also assesses
the potential challenges and obstacles that hold back the establishment and operation of
Interest free banking in cases of CBE.

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1.3. Research questions:
The study attempts to answer the following research questions.

1. Can interest have negative impact on Ethiopia economy and social relation of the
society?
2. Does Interest Free Banking have opportunity in Ethiopia if established and starting to
work?
3. Is there any challenge and obstacle that can obstruct the establishment and operation
of interest free banking in Ethiopia?
4. Does interest free banking supplement the investment opportunity in Ethiopia?
5. Is commercial Bank of Ethiopia Full-informative to its Non interest Users or
customers?

1.4. Objective of the Study

1.4.1. General Objectives
The general objective of this study is to show the possible opportunities of Interest free
banking in CBE and to assess and find out the probable potential challenges and obstacles
that hinder the successful establishment and operation of Non-interest banking in cases of
CBE.

1.4.2. Specific objectives

The specific objective of this paper is,

1. To show how non-interest banking is operating.

2. To determine if Interest free banking supplement investment opportunities in
Ethiopia.
3. To assess if there is any challenge that affect the growth and development of Interest
free banking in Ethiopia.
4. Assess if commercial bank of Ethiopia is full informative to its Interest free banking
customers.
5. To find out potential obstacle/challenges for Interest free banking upon establishment
and operation in Ethiopia.

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1.5. Significance of the study
The establishment of Interest free banking will have too advantage for Ethiopia. To establish
and obtain the maximum benefit from the new banking system it is important to make the
environment clear from obstacles and challenges. So that this study has taken into account the
following benefit and beneficiaries. Firstly, to bankers and finance institution it provides
another window to expand their profit and service. Secondly, it will show benefit and
opportunity of interest free banking to individual and institutional investors of Ethiopia who
wants to invest in this sector; finally, it gives highlights to the government office who has
related to banking activities. In general, the research paper would play a significant role for
the development of and betterment of the finance sectors as well as to avoid misconception
from Interest free banking system.

1.6. Scope of the study

The study has been conducted only based on the processes and methodologies used. The
researcher was assessing the rationales behind the prohibition of interest, the need for Interest
free banking, and some of many opportunity of interest free banking in Ethiopia. It also
addressed the probable potential operational challenges of this bank in cases of CBE only.

1.7. Limitation of the study

Obviously, there is no research activity which is perfect or undertaken without any limitation.
Likewise, in the study the researcher had faced obstacles and problems that have limited of
the study. Among others, lack of sufficient time and information were the core ones. In
addition, the following problem had taken as limitation for this study. The majority of
respondents lack of knowledge about Interest free banking, Unavailability of compiled
secondary data, and unavailability of well-organized research center relating to these studies.
These and other micro and macro problems are taken as a limitation.

1.8. Organization of the paper

This paper would be divided into five chapters. The first chapter deals about the introduction
of the study which is background, statement of the problem, objective, significance, and
research questions. The second chapter discusses the literatures about Interest free banking.

The third chapter deals about research methodology.

The data presentation, analysis and interpretation will be presented in the fourth chapter.

Finally, the fifth chapter deals with conclusion and recommendation.

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 CHAPTER TWO

2. LITERATURE REVIEW
This literature review illustrates the concept, scope and principles of Interest free banking

2.1. Introduction to Islamic Banking

Islamic banking appeared on world as a prominent player was in the early 1970’s. But rules
and regulations governing Islamic banking system has been present in the world for many
centuries (www.islacmicbanking.com). Islamic financial system is existed in Muslim
community in different shapes according to situation of time. Actually Islamic financial
system has a capability to fulfill the society requirements in respectable way (wassem
Ahmad, 2008). Islamic finance has become a global system spreading as far as Asia the
Middle East, and the western world. Islamic banking is not limited only to the Muslim nation

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in the Middle East but also exists in the developed economies such as USA, Europe, and the
Far East.

Islamic banking (interest free banking) is a growing sector with its diversity in different
segments and spectrum. It caters to religious Muslims in Muslim’s societies as well as in
countries where Muslims are in minority. In addition, it is a broad standard non-Muslim
individual and communities that seek ethical financial solutions have also been attracted to
Islamic banking. It is clear from banking practice that Islamic banking is equally popular in
all communities (www.hsbcamanah.com).

It is clear from above statements that Islamic banking is not only specific to Muslims but
actually it is a system which provides financial services which includes the non-Muslim
society with more options other than the conventional banking services.

The organization of Islamic conference (OIC) defined an Islamic banking as “a financial

institution whose statutes, rules and procedures expressly state its commitment to the
principles of Islamic and to the banning of the receipt and payment of interest on any of its
operations” (Siddiqi& Mohammed, 1969). According to this statement it is clear that interest
is fully prohibited in Islamic law.

Islamic financial system is not a new practice. Its roots belong to the early days of Islam and
in the age of Hazart Umar it was available in a disciplined form, all financial matters of state
solved through Islamic financial law. Islamic financial system is gradually improved and now
days it is recommended and exercises by many Muslim countries as well some non-Muslim
countries especially UKs, USA and Australia (Wassem Ahmad, 2008).

Although interest free banking is very famous in Muslim and non-Muslim communities and it
is a system which has a complete financial and economic solution but still Islamic financial
and banking system is not well organized in non-Muslim countries. Islamic banking is facing
the challenges of lack of fund management and lack of proper institutional set up to run infant
system. Comparatively the conventional banking system has strong financial and institutional
network in all Muslim and non-Muslim countries (Wassem Ahmad, 2008).

2.2. Principles of Islamic banking

The principles of Islamic banking are based on Islamic law, known as sharia, which mean:
interest cannot pay or received on transactions in any case where money is exchange for
money because the money is not actually any value accordance to Islam if it’s not employed

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in business, transactions must avoid uncertainty (Ghrar) speculation (Maysir) or anything that
could lead to the unjust enrichment or unfair exploitation of one of the parties to a contract. In
case of speculation the big investors and industrialists turn the economic financial system
toward their own and personal benefits. Transaction cannot be made that involve prohibited
products or activities such as alcohol illicit drugs and tobacco because Islam wants to develop
an ethical and friendly environment in the society (Siddiqi & Muhammad, 1969).

2.3. Prohibition of Interest

Although the fact of prohibition against interest in Islamic banking is axiomatic, a variety of
arguments have been provided by Islamic scholars to explain and justify its application. One
argument which has not received any attention in the literature on Islamic banking, and which
goes a long way in justifying the prohibition, is based on Islam’s position on property rights
and obligations and its conception of economic justice (Mohsen & Muhammed,1987).

Money represents the monetized claim of its owner to property rights created by assets that
were obtained through work or transfer. Lending money, in effect, is a transfer of this right,
and all that can be claimed in return is its equivalent and no more. Thus, interest on money is
regarded as representing unjustified creation of instantaneous property rights: unjustified,
because interest is a property rights claimed outside the legitimate framework of recognized
property rights; instantaneous, because as soon as the contract for lending upon interest is
concluded, a right to the borrower’s property is created for the lender. On the other hand,
when the financial capital of the lender is used in partnership with the human capital and
labor of the entrepreneur, the lender’s rights to his property is no transferred and he shares, as
co-owner, the final product his money has helped to create. He will be remunerated in
proportion to his financial investment in the ensuring incremental wealth. This emphasis on
profit sharing provides the basis for the development of an Islamic financial system (Mohsen
& Mohammed, 1987).

In broad terms, the transformation of banking from an interest based system to one that relies
on profit and loss sharing makes an Islamic banking system essentially an equity based
system. In such a system depositors are treated as if they were the shareholder of the bank,
and consequently are not guaranteed nominal values, or a pre-determined rate of return, on
their deposits. If the bank makes a profit, the shareholder (depositor) is entitled to reactive a
certain share of it; on the other hand, if the bank incurs a loss, the depositor is expected to
share in it and thus receive a negative rate of return. From the depositor’s perspective, then,

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an Islamic bank is in most respects identical to a mutual fund or an investment trust.
Furthermore, to remain consistent with religious strictures, banks cannot charge interest on
their lending operations, but have to use special modes of investment and financing that are
also based on profit and loss sharing (Mohsen & Mohammed, 1987).

2.4. Fundamental of Islamic banking

Islamic banking has the same purpose as convention banking to make money for the banking
institute up lending out capital. But that is not the sole purpose either. Adherence to Islamic
law and ensuring fair play is also at the core of Islamic banking. Because Islam forbids
simply lending out money at interest, Islamic rules on transactions (known as Fqgh al-
Muamalt) have been created to prevent it. The basic principle of Islamic banking is based on
risk-sharing which is a component of trade rather than risk-transfer which is seen in
conventional banking. Islamic banking introduces concepts such as profit sharing
(Mudarabah), safe keeping (Wadiah), joint venture or partnership finance (Musharakah), cost
plus (Murabehah/Murababha) and leasing (Ijar) (en.wikipedia.org).

According to Ahmed, 2008 study classification the fundamentals of Islamic principles are as
follow.

1. Musharakah (partnership finance)

Masharakah is a contract in which the bank and the industrialist contribute jointly to the
capital of a company or project to make a profit, profit and losses are shared between the
parties on agreed term and condition of the contract.

2. Mudarabah (Trust financing)

Mudarabah is a contract. In this contract the responsibility of bank provides all the capital
while the partner contributes commercial efforts, professional skills and experiences. Finally,
the bank receives a pre-determined proportion of the profits. In the case of aloes, the bank
bears all the financial loss whilst the manufacturer goes unrewarded. It is concluded that this
system encourages the individual to participate in financial activity and prove himself as an
active part of society.

3. The third principles and the free charges among the principles within the fixed
charges category are:
i. Murabaha (cost-put financing)

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The murabaha is a contract in which the bank informs the industrialist about the acquisition
cost a good and negotiates with him the profit margin. It is one of the most popular modes
used in Islamic banking system in different countries to promote interest-free transactions.

ii. Bai-mua’jjal (deferred payment sale)

The Bai-mua’jja is a deferred payment sale contract which is traded without additional costs.

iii. Ijara (leasing)

The Ijara is a rent contract by which the owner of the good rents it another party beading it.
After that the latter can purchase it and rent is reduced until the good become the possession
of the client. Nowadays the Home finance and Islamic mortgage and based on the concept of
Ijara and it is very successful tool in Islamic financial system.

iv. Quard Hassan

In Islamic financial system the customers who are facing financial crises or unpredicted
expenditure banks provide welfare loan without paying any fees or interest.

2.5. Compatibility of Islamic banking with conventional banking

Islamic banking has same purposes and practice and conventional banking except that Islamic
banks operate in accordance with Sharia laws. The basic principles of Islamic banking are the
sharing of profit and loss between contracted parties and as well very strongly prohibit the
Riba (interest) (Wassem Ahmed, 2008).

Islamic and traditional banking actually are not different they both banking system has same
objective and practices the only difference of implementation of interest because interest is
totally prohibited in Islam. Islamic banking falls into the realms of conventional banking;
Islamic banking try to ensure that all their financial natters according to Islamic financial law
as well as the rules and regulations of a particular state like the financial services authority
(FSA) in the United Kingdom Islamic banking almost provides some service as conventional
banking such as current accounts, serving, accounts, insurances, mortgages and investment
opportunities in the society (Wassem Ahmed 2008).

It is resulted from these statements the functions of Islamic banking are matched with
traditional banking system such as conventional banking charge interest against Islamic
banking provides these services with charging of services fees and mortgages rate are most
likely same in both banking system but only difference that Islamic banking follow the Ijarah

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rules in which the installment is calculated on the basis of monthly rent plus services fees of
the banking institution (wassem, Ahmed, 2008).

2.6. Status of Islamic banking in Ethiopia

According to (Mohamed, 2012) Islamic banking is at an incipient stage. The existing legal
framework does not permit full-fledged Islamic Banking a lot of amendments need to be
carried out in the prevalent legal set up while appropriate models need to be selected and
implemented to suit society’s diverse financial needs.

As Mohammed’ study paper in 2012, to accommodate Muslims, who are by sharia’s Islamic
low prohibited from taking, or giving interest (Riba), commercial banks were offering zero
interest (special demand deposit). However fully fledged establishment of Islamic banks,
which offers the owners of capital to share the profits made by the entrepreneur who comes
up with investment project, is an untapped concept of the local finance sector.

Islamic banking launched in Ethiopia first by commercial bank of Ethiopia then other banks
like Oromiya bank follow opening window units.

2.7. Challenges of Islamic banking

Islamic banking is doing well in the world economy but some of the potential opportunities
and challenges should be taken up to make Islamic banking more user friendly in every
segment of economy and society. There is needed to make a clear and transparent system of
general. Islamic banking which concerned to all sectors of society and economy in order to
address the challenges and threats of the future needs of the financial sector (Wassem,
Ahmed 2008).

Despite the growth of Islamic banking over the last 30 years one of the main challenges
facing Islamic banking is the poor understanding about its operating in the Muslim and non-
Muslim world (Mohamed 2012).

Islamic banking is at an early stage of learning and experience, lacking the flexibility to
choose arrangements which best suits their need in reacting to structural shifts in the
economic setting as well as challenges in consumer preference. For example, Islamic banks,
without have and interest free money and capital market will not have adequate instruments
to meet the pre-condition for liquidity management and effective maturity transformation
(Mohammed, 2012).

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Whatever the goal and functions are, Islamic banks come into existence in an environment
where the laws, institutions training and attitude are set to serve and economy based on the
principles of interest. In non-Muslim countries (i.e. countries with less than 50% Muslim
population), central banks are very stringent in granting licenses for Islamic banks additional
requirements if mother government and non-government authorities. So, apart from legal
constraints, there are economic measures that result operations of Islamic banks in non-
Muslim world difficult (Mohammed, 2012).

Many Islamic banks lack liquidity instruments such as treasury bills and other marketable
securities which could be utilized either to cover liquidity shortages or to manage excess
liquidity. This problem is aggravated since many Islamic banks work under operational
procedures different from those of the central banks; the resulting non-compatibility prevents
the central banks from controlling or giving support to Islamic banks if a liquidity gap should
occur (Mohammed, 2012).

Despite there are high demand opportunities that make to launch and precede Islamic banking
there are a lot of challenges that could hinder the growth and development of the system
which I have come to understand.

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 CHAPTER THREE

3. RESEARCH METHODOLGY
3.1. Research design
In order to achieve the stated objectives of this study descriptive research design has been
adopted to gather as much information as possible to show the opportunities and challenges
of interest free banking service of commercial bank of Ethiopia.

3.2. Source of data

To conduct this research both primary and secondary data were used. The sources of primary
data were from employees and selected customer of the bank. The Secondary data also
collected and used to describe and elaborate the conceptual aspects of interest free banking.
In addition to this different websites and books written by various authors were used as data
collection instruments.

3.3. Methods of data collection

3.3.1. Types of data
For accomplishing this research work and research objectives both primary and secondary
data was collected.
The primary data was collected from those employees and selected customers of the bank.
Thus, in order to obtain the reliable and sufficient information, partially self-administered
questionnaires were used as data collecting instruments.
In an effort to make the research more valid, credible and applicable secondary data were
used for the issues rise on the research. For this purpose, published sources, i.e. different
books and Webpages were investigated.

3.3.2. Procedure for data collection

In order to collect sufficient data that can answer this research questions, the researcher
designed questionnaires to bank employees and selective customers who have related to their
day to day activities. Data from both primary and secondary sources were collected and
organized in the form of tables.

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3.4. sampling size and sampling technique
From total population of thirty-five employees of commercial bank of Ethiopia six employees
were selected as a sample size by using purposive sampling techniques, because these six
employees were especially engaged in the area of interest free banking services. The
researcher also used purposive sampling techniques to select 10 customers of commercial
bank of Ethiopia from total populations.

4. Work Plan and Budget Schedule

4.1. Work Plan

Work plan is schedule chart or graph that summarizes the different components of a research
and how they will be implemented in a coherent way with in specific time from February
2024 to June 2024.

No Research activities Duration of time

Feb Feb March March Apr May June

1 Select the topic 👍

2 Prepare proposal and submit to 👍 👍

department

3 Obtain fund discuss arrangement 👍

with advisor

4 Preparation of study tool 👍 👍

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5 Prepare for field work 👍 👍 👍

6 Travel to data collection site 👍 👍 👍

7 Select data collectors and research 👍 👍 👍

assistance

8 Conducting training for data 👍 👍 👍

collectors

9 Pre-testing of survey instrument 👍 👍 👍

10 Data collection 👍 👍 👍

11 Data analysis and writing the first 👍

draft and editing

12 Sub-mit the final research 👍

13 Presentation and defense of the 👍

research

4.2. Budget Schedule

A detailed budget will help to identify which resources are already locally available and
which additional resource may be required.

No Items Quantity Unit price Total price

Birr Cents Birr Cents

1 Pen 8 20 - 160 -

2 Paper 1 600 - 600 -

3 Telephone 5GB 100 - 500 -

4 Transport - - - 500 -

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5 Photo copying 50 4 - 200 -

6 Research bundling 2 500 1000

Total - - 2,960

References
- Mohsen, S.K., Abbas, M., (1987). Theoretical studies in Islamic banking and Finance.
USA: Institute for Research and Islamic studies.
- Siddiqi, Muhammad, N., (1969). Banking without interest. Saudi: Ghairsudi bank
Kari.
- Mohammed, M.O., (2012). Islamic banking. Addis Ababa, Ethiopia: Islamic Research
& Cultural Center.
- Wassem, A., (2008). Islamic banking in United Kingdom. London: Kingston
University.
- Wikipedia (May 2014). History of commercial bank of Ethiopia. Retrieved from
http://en.wikipedia.org/wiki/Islamic-banking

15
- Abdul Gafoor,M, 1995.Interest free commercial banking
- www.combanketh.et
- www.islamicbanking.com
- www.hsbcamanah.com

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