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Is Islamic Banking, The Way Forward

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What happens when it’s not just a lack of physical banks preventing communities’ access to financial services, but ethical issues too? Islam is the world’s second largest religion with more than 1.5 billion followers, making up more than 23% of the world’s population. Of these, 650 Muslims hover at or below the poverty line. But although Islamic-compliant finance is a huge industry globally, when the international community talks about improving access to financial services in developing countries, making services Islamic-compliant is rarely top of the agenda.

Islamic-compliant financial products can take several forms and business models. However, the principles of Islamic finance are universal: you cannot make money off money. No one can charge or pay interest, or invest in items that Islam forbids such as alcohol and gambling.

Although a growing industry globally, within Ethiopia Islamic banking, which is also referred to as interest-free banking, is in its infancy. Around a third of Ethiopians identify as Muslim, making the country’s Muslim population larger than that in Saudi Arabia, Syria or Yemen. Access to finance in Ethiopia is generally very low. Nationally, only 14 % of the adult population has access to formal credit and savings products but this rate drops to 1% in rural areas. And, until recently, there were no financial institutions catering to the large population requiring Islamic-compliant products.

In the past this was due to the lack of development in the country and consequently very few financial institutions. Banks and other institutions providing appropriate loan products just did not exist, interest-free or otherwise. But wherever you live, whatever your needs are, financial services must be tailored to your needs. For example, in the agricultural sector, farmers want to repay a loan with small payments until harvest when a balloon payment is made.

The idea of creating an infrastructure to support Islamic banking in Ethiopia has gained more support in recent years though, and in 2008, a proclamation by the National Bank of Ethiopia (NBE), Ethiopia’s financial regulator, introduced interest-free banking in Ethiopia, and then in 2011, issued formal directives on Islamic-compliant finance.

That same year Mercy Corps decided to focus a large portion of our work in Ethiopia on increasing interest-free financial services to the least-served areas of the country. These areas are in pastoral Ethiopia, which represents 60% of the country’s landmass and hold 40% of the country’s livestock, especially camels and cattle – a mainstay of the Ethiopian economy. Three of these regions – Afar, Somali and Oromia – are the country’s most dynamic, serving as economic and trade corridors to Kenya, Somalia and the Gulf.

With USAid support, we launched the Somali Microfinance Institution, the first provider of interest-free microfinance services in the country – offering loans, savings, and money transfers. The Somali MFI has now scaled up to have 16 branches and over 6,000 active clients. Rural Ethiopia has a 125,000:1 person-to bank-branch ratio and there is also a need for financial services closer to home. This is a gap that mobile banking could fill, even though, compared to its neighbours, Ethiopia’s mobile phone penetration is low due to a government monopoly.