Tuesday, October 29, 2013

Commercial Bank to Launch Interest-Free Banking

Banks can offer interest-free banking services alongside their conventional operations

The Commercial Bank of Ethiopia (CBE) will launch interest free banking as of Monday, October 28, 2013, in 23 selected branches in Addis Abeba and in other major regional towns.

The service, which will be offered on separate windows, can be used by individuals, government institutions and nongovernmental organisations (NGOs). Services offered under the interest-free banking include deposits, foreign exchange and money transferring services, and will be available for customers who engage in trade partnerships, agricultural forwards contracts, construction, manufacturing and import-export trade, the Bank says.

The service does not include traditional loans that require interest payment by the borrower, according to Ephrem Mekuria, communication manager at CBE, but instead provides financing through a different method, where the borrower enters an agreement with CBE whereby it will pay a percentage of its profit to the Bank as repayment. This means that it is both a risk-sharing and profit-sharing agreement, Ephrem said.

Interest-free banking mainly targets individual and institutional customers that do not want interest on their deposits because of reasons such as religion. The National Bank of Ethiopia’s (NBE) directive that guides the interest-free banking business, defines the service as mobilising or advancing funds that is undertaken in a manner consistent with Islamic finance, which avoids receiving and paying interest.

According to an official at the NBE, the central bank must be notified 15 days in advance of a bank starting such a service.

“We have done so and have already received approval,” stated Ephrem.

The NBE’s directive came into force in October 2011, but interest-free banking in Ethiopia started only in 2013, when Oromia International Bank (OIB) launched the service a few weeks ago.

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

The directive also orders banks not to alter the maximum share of interest-free banking business in their consolidated balance sheet without prior approval from the central bank; a violation here could lead to a closure of the interest-free banking window.

A senior bank expert who talked to Fortune cautions, however, that deposits made in interest-free banking may be more vulnerable than in conventional banking. “While interest-free deposits strengthen banks’ financial arm, high inflation can erode the value of the depositors’ money since they are not earning interest,” he said.

For banks, however, the expert notes that this banking method could be recommended as a good means of mobilising financial sources.

In preparation for the launch of the new service, the CBE has been training staff and customising the existing information technology (IT) system, according to the communications manager.

The CBE, a state-owned institution established in 1942, is the largest bank in the country. It currently has 725 branches nationwide, and earned 8.4 billion Br gross profit in the previous fiscal year.