Sharia-compliant finance boosts financial inclusion in Ethiopia, but a fully-fledged Islamic bank has yet to take root.

Addis Ababa, Ethiopia – It’s afternoon in Addis Ababa’s bustling Bole Michael district, and businesswoman Hukun Aden Mohammed is doing a brisk trade.

The 45-year-old, single mother of seven opened her modest cosmetics and snack shop in the heavily ethnic Somali neighbourhood two years ago.

Business is so good, she’s planning to grow and diversify.

“I plan to expand my business by opening up a shoe store,” Mohammed told Al Jazeera. “Inshallah (God willing) I also plan to open businesses in my home city, Jijiga in Somali regional state and across other parts of Ethiopia.”

Ten years ago, Mohammad, an observant Muslim, would have struggled to find funding that aligned with her religious beliefs.

But Ethiopia‘s measured embrace of Islamic banking is offering her and other entrepreneurial-minded Muslims a gateway to financial inclusion.

She started her business with a loan from the Somali Microfinance Institution (SMFI), Ethiopia’s first provider of sharia-compliant microfinance services.

“I first received around 7,000 Ethiopian bir ($246) loan from SMFI and with my business successfully expanding, I have recently received a loan of around 75,000 Ethiopian Birr ($2,645),” said Mohammed.

Unlike conventional finance, sharia-compliant financial institutions do not charge interest on loans. Instead, they share in any potential profits or losses of the businesses they underwrite.

A typical day in the Bole Michael neighbourhood of Addis Ababa [Michael Tewelde/Al Jazeera]

They also refrain from lending to businesses that engage in or promote activities prohibited under Islamic law, such as gambling, or selling pork or alcohol, or selling services that promote “immorality.”

The vast majority of SMFI’s loans are structured as resale agreements known as Murabaha, where the bank purchases goods for its client and then sells the goods back to them at a slightly higher price than the original cost. The customer can then repay the loan in instalments.

For Mohammad, Islamic banking services have transformed her financial life.

“The loans from Somali Microfinance Institution have already allowed me to support the needs of my children, pay for my accommodation and business rent,” she said. “With future loans from SMFI, I plan to buy house or land to expand my business and build a stable home for me and my family.”

Boosting financial inclusion

While financial inclusion has improved in Ethiopia, it still lags behind the rest of sub-Saharan Africa.

The percentage of adults in Ethiopia with a bank account increased from 22 percent in 2014, to 35 percent in 2017, according to the World Bank Global Findex database.

In Kenya, by contrast, 82 percent of adults had a bank account in 2017.

Part of that gap can be attributed to mobile money uptake, which is far greater in Kenya than Ethiopia.

While the drivers of that difference are not fully understood, Islamic banking is helping to boost financial inclusion in Ethiopia by reaching communities which formerly felt excluded from the country’s banking sector.

Though roughly a third of Ethiopia’s estimated 105 million citizens are believed to be Muslim, formal directives on Islamic law-compliant finance were only issued by the National Bank of Ethiopia (NBE) in 2011 – the same year SMFI opened its doors.

SMFI has since served around 30,000 customers, mostly in rural communities in Ethiopia’s eastern Somali region. Islamic law-compliant microfinance institutions have also sprung up in Ethiopia’s Afar region.

Inching towards a fully-fledged Islamic bank

SMFI hopes to evolve from a microfinance institution into a fully-fledged Islamic bank – a hurdle no Ethiopian financial institution has cleared yet.

“Regardless of whether we become a fully-fledged sharia-compliant bank in the future, we plan to expand our services to other parts of Ethiopia serving interested customers, Muslims and non-Muslims alike,” Ubah Hassan, senior saving and credit officer at SMI, told Al Jazeera.

While most big banks in the country have a window where customers can access Islamic financial services, a dearth of expertise in Islamic law-compliant banking has hampered past attempts to form an Islamic bank.

The proposed Islamic bank Zamzam stalled in 2012 when it failed to satisfy NBE directives on interest-free banking issued the year before.

“We didn’t have experienced personnel in Ethiopia on sharia-based banking services and products in Ethiopia previously,” Solomon Desta of NBE told Al Jazeera. “That’s why we initially opted to start with interest-free window banking services.”

Ubah Hassan prepares to give 75,000 Birr ($2,645) in loans Hukum Aden Mohammed [Michael Tewelde/Al Jazeera]

Abdillahi Farah, financial inclusion adviser at Mercy Corps Ethiopia which helped launch SMFI, said Islamic law-compliant windows in big banks do not go far enough for some customers.

“Sharia-compliant MFIs have attracted customers who have felt banks don’t represent them even though they have window-based interest banking system as some suspect it’s a compromised banking practice,” he told Al Jazeera.

But Ethiopia may be inching closer to green-lighting an Islamic bank.

Efforts to create a more hospitable climate for Islamic banks have been renewed since Prime Minister Abiy Ahmed, a Christian whose father is Muslim, came to power in April 2018.

And many see greenlighting Islamic banks as part of a greater liberalisation drive to attract more foreign investment, including the NBE, which is preparing a study to assess the impact of allowing fully Islamic law-compliant financial institutions.

“Ethiopia is looking on how to comprehensively liberalise the financial sector,” said Desta. “Ethiopia is geographically close to Middle Eastern countries that have lots of money which can be easily mobilised to invest in the country.”