Merkato, once proclaimed to be the single largest open-market place in Africa, seemed to be evolving overtime. In the past decade alone, Merkato has undergone a significant level of transformation.

For one, a better part of this old market establishment can no more be called an open market with new high-rise buildings housing most of the shops and storage facilities, these days. And together with that, a number of new coffee shops and other service giving entities are now popping up in Merkato targeting the tens and hundreds of thousands that rumble through the market every day.

Nevertheless, Merkato is still the nerve center of Ethiopia’s trade and commerce activities. They say, easily, goods and services worth millions of birr changes hands every day. In fact, Merkato might as well be the single largest market place in Ethiopia in terms of the volume of cash-based transacting activities.

Although notorious for its street-smarts and illusive traders and businessmen, Merkato is also a place where huge amounts of financial dealings are made solely based on trust and social networks.

Every day, a staggering amount of short term business-to-business loans and financing decisions are made in Merkato; and most of it is truly based on trust and social networks, posing a serious challenge to tax administration and trade regulation. Some of the traditional, social saving-credit collectives aka equbes are said to be as large as hard-to- come-by bank financing facilities. However, such non-conventional business interactions are not always a matter of choice for those involved.

In fact, Muslim members of the business community are and had been severely underserved by the nation’s financial industry. For there are no financing instruments that can cater to the needs of the Muslim community both in Merkato and the rest of Ethiopia, resorting to informal financing mechanisms is indeed no surprise. The conventional banking sector is one of the major players in the Ethiopian financial system to have failed this significant portion of the business community.

A service as simple as opening a checking account or access saving or loan instruments was difficult for Muslim members of the business community for the entire banking industry in Ethiopia and was limited to offering a conventional interest-based banking products to clients; whereas interest and other speculative financial instruments are basically in contradiction with the basic Islamic laws and principles.

This, in turn, had massive consequences to the business environment as it distorts the level playing-field and eventually the market. On the other hand, the banking sector, as a lucrative investment area, also stayed closed-off to Muslim investors.

This, however, seemed to be changing in 2011 with the enactment of the nation’s first interest-free banking directive by the National Bank of Ethiopia. The directive that authorized the business of interest free banking in Ethiopia was highly shrouded with controversy back when it was enacted.

The months leading to the enactment of the directive saw the emergence of the first financial institution in Ethiopia that seeks to operate on the basis of an interest-free banking scheme which is also consistent with the Islamic principles: Zemzem bank. Although still under formation, Zemzem dominated debate platforms, discussing the importance of an Islamic financial institution in Ethiopia and how it operates.

However, it was a short-lived party to say the least. Soon, the most anticipated national bank directive sealed the fate of the first interest-free bank in Ethiopia. The directive only authorizes interest-free banking window in the setup of a conventional banking system and not a full-fledged Islamic bank.

The news hit the bank and it’s pledged shareholders pretty hard. Accordingly, the existing private and state-owned banking institutions were not quick to capitalize on the window that opened up by the directive; not until Oromia International Bank, which was only 5 years into the banking business at the time, took the step to pioneer the first interest-free banking window in Ethiopia, in October 2013. Including the state-owned Commercial Bank of Ethiopia (CBE) a number of banks from the local finance sector followed suit.

And exactly six years later, the once frustrated Zemzem returned to the finance scene. But this time around with two more potential full-fledged Islamic banks namely Zad and Hijra. The three have officially started selling shares while unofficially at least two more banks are said to be in the pipeline to take part in the interest-free banking game. This will bring the total number of new entrants to five.

Islamic law scholars and Shari’ah experts allude that the emergence of an Islamic financial system is important since Islam by its very nature is a religious framework that encompasses all aspects of the life of the observant. This is where financial instruments that are completely consistent with the Islamic belief and principles become a necessity. Islamic finance is generally governed by three principles: equity, participation and ownership.

This goes with the other two principles of participation (where reward (profit) is linked with risk taking and real and productive activities) and ownership (underscoring the sanctity of property right and ownership) to fully form the principle behind Islamic financing. These very principles set Islamic banking apart from the conventional one, according to Jamal Muzeyin, Banking business professional and organizer/promoter of Zemzam bank.

“To truly understand what sets Islamic (interest-free) banking institutions apart from conventional banking,” Jemal says, “first we need to clearly define what banking services really mean in this modern business environment.”

Banking services can really be summarized in three broad categories, according to Jamal, which are payment facilitation; service charge and fee based services like Letter of credit, foreign exchange trade, money transfer and the like; and the third and last one which has to do with mobilizing deposits and channeling funds to borrowers.

With regard to project financing under the Islamic financing scheme there appears to be two possible contractual arrangements between the bank and its clients. According to the scholars, it could either be “profit and loss sharing arrangement (Musharakah) or profit sharing and loos-bearing arrangement” (Mudarabah).

And hence, in Musharakahn contracts, banks and clients can enter into a joint partnership with a full right to participate in managerial decisions and also bearing the highest risks from all modes of Islamic financing. Even though profit is shared agreed up-on proportion, losses are usually born according to capital contribution of the partners.

Nevertheless, Mudarabah is about forging partnerships as financier and agent, the latter providing the managerial and entrepreneurial expertise towards generating a profit. The financier obviously bears all losses while profit is shared according to the agreed up on proportion.

As far as banks acting as commodity traders, the standard financing products dubbed Murabahah entails Islamic banks buying commodities and services to be resold by their clients at a payment deferred for a latter period.

Apparently, there are variants of the specific contractual agreement to be concluded between the bank and client. In this regard, the bank and the client can agree on a price markup or profit sharing arrangement from the proceeds of the sales of goods and services by the client as compensation for financing services.

In fact, data shows that about 80 percent of the entire global Islamic financing portfolio, at this point in time, involves Murabahah in one way or the other. This is especially true for the nascent Interest free window operated by local banks in Ethiopia.

“In Ethiopia, Murabahah’share could be as high as 90 percent of the overall Islamic financing activities,” says senior banking professionals working with private banks operating an interest free window.

So far, the local interest free windows are reported to have done well in terms of mobilizing deposits. In fact, some reports put the level of deposit mobilization by eleven banks (operating interest free windows) at 40 billion birr, which is unprecedented in the space of 5 years since they launched their operation.

In the overall Islamic financing framework, depositors and the banks relationships as well are quite different from the conventional one. Since there is no interest payments, depositors in interest free banks deposit their money either for the sole purpose of safekeeping or facilitating their payments or wanting to reap the benefits of profit sharing from the operation of the bank.

According to pundits, depositors have options either to share the benefit form specific projects or from the general operation of the Islamic bank. The proportion of the profit sharing the bank offers to depositors depends on, of course, the type of the deposit or the level of risk they are willing to stomach.

The only way depositors differ from actual shareholders of an Islamic bank is in light of the latter’s voting right in the matters of the banks and protecting its interest. Nevertheless, Jamal as well admits that the existing Islamic banking windows in the market are yet to realize the full potential of the Islamic financing system.

“I say this since, as they currently operate the Islamic banking window in Ethiopia, almost 90 percent of their activities are limited to offering the services of sellers of goods and services,” he argues.

Jamal admits that the legal and administrative regulatory frameworks facing the interest-free banking windows in Ethiopia are yet to improve. Jamal questions the logic of placing a limit on the mainline of business of an industry.

“You see Islamic banks are like investment banks, they can’t survive if they can’t invest,” he argues, adding that double taxation problem regarding financing of goods and services and ownership transfer are also other areas that need to be looked at by the regulatory body.

Since Murabahah takes the overwhelming share in the business of interest free banking in Ethiopia, the banking professional said that the newer banks need to secure a sustainable source of foreign exchange by building their clientele in the export business, which, given the current business environment in Ethiopia, could prove to be a very daunting task.

Notwithstanding the huge capacity gap in project analysis and management in the industry, the customary business practices in Ethiopia could also prove to be another daunting challenge for Islamic banks, according to Jamal.

“We know most of our businesses lack in the area of proper financial bookkeeping and ethical business practices; this is a big problem for Islamic banks since the nature of the business they are in requires them to be actual partners to projects they wish finance,” he explained to The Reporter.

He asks how many of the local companies in Ethiopia have properly audited financial reports; and how many of them discharge their tax obligations properly and on time? Furthermore, Jamal is also concerned about the overall business culture.

“Islamic banks will enter into business partnerships with companies trusting that they will have an ethical business conduct. How many of these companies have trust worthy financial statements?” he asks.

Banks under Islamic financing system offer products where they not only have profit sharing arrangements but bear the losses of these projects they finance. That, according to Jamal, puts the banks in a difficult situation if the business practice is not ethical and lacks trustworthiness.

Source The Reporter