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January 19, 2019

IFB Background

 

Interest free banking (IFB) refers to a banking business in which mobilizing or advancing of funds taken in a manner consistent with Islamic finance principles and mode of operation that mainly avoids receiving or paying interests through units or windows within the conventional bank that exclusively offers interest free banking services.

The Shari’ah law treats transactions based on interest payments unlawful or haram/forbidden.  Majority of the scholars in Islamic finance and economics argue that the involvement of interest rate or Riba violates the principles of social justice as it intentionally rewards those money lenders without exerting any effort or taking any risk in the transactions involved.

The key issue is that a predetermined profit or income should not be guaranteed to the finance providers without sharing the risks of the ventures or projects financed. Sharing of gains in a given venture should be intimately linked with risk-sharing. Alternatively, the principle dictates that Banks should raise their funds based on Safe-keeping or Agency contracts, and bank financing base itself on sales or trading, and leasing which involves substantial risks for both the lender and the entrepreneur using the bank finance. The customer-banker relationship in IFB is not, therefore, based on a debtor/creditor, which is the case of conventional banks.

As the Commercial Bank of Ethiopia (CBE) is licensed by the National Bank of Ethiopia to give these services, it would provide the services at specified windows of selected branches of the bank. Interest free banking is available to all customers who want to make use of the alternative banking service. CBE has a separate and dedicated system that does not mix the movement of accounts in those windows with the regular ones.


Financial Administration

o   Profit Equalization Reserve: - is a fund left from Net Income of the pool during periods when the profit to be paid to customers are above market price, which helps to smoothen the regular profit payment to the depositors. In other words, the PER used to improve the returns to the depositors during periods when the pool’s [profits are below market expectations.

Prices shall be determined based on the supply (deposit) and demand (finance), thus the profit payable shall also vary accordingly

o   Investment Risk Reserve: - the pool may incur losses primarily due to unusually large write-offs and/or losses on sale of the pool’s investments or financing different products. To absorb or off-set the losses the Banks may create the investment Risk Reserve (IRR) to cover the future investment losses.

o   Cash holding

o   IFB Special Account

 

Profit Distribution

 

The distribution of profit or loss on Mudaraba Saving Account or Mudaraba Deposit Account is depend on the profit or loss involved in financing product or investment. Profits are distributed after the bank has collected commission income and other similar incomes for the service of financing.

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