How Islamic Finance Can Drive Growth and Prosperity In Ethiopia

Jibril Mohamed Ahmed(PhD), Founder & CEO of Sahanease Solar.

I remember a conversation I had with an elderly businessman in Addis Ababa a few years ago. He lamented how the traditional banking system had alienated many Ethiopians who viewed interest-based financing as both economically oppressive and religiously forbidden. "If only we had a financial system rooted in justice and fairness," he said, "our communities would thrive."

This sentiment isn't unique to him. It's shared by millions of Ethiopians, especially those who have been excluded from formal financial services due to cultural and religious reasons. Today, as Ethiopia embraces Islamic finance, the question we must ask is not whether it can work, but how we can harness its full potential to drive economic growth, job creation, and local development.

Many people mistakenly view Islamic finance as an exclusive financial model for Muslims. This misconception often limits its acceptance and integration into broader financial systems. However, in countries like Malaysia, the UK, and South Africa, Islamic finance has proven to be an ethical, inclusive, and stable financial system, appealing to both Muslims and non-Muslims alike.

At its core, Islamic finance is built on equity-based financing, risk-sharing partnerships, and socially responsible investments. Unlike conventional banking, which is centered on interest (Riba), Islamic finance promotes profit-and-loss sharing models like Mudaraba (investment partnerships) and Musharaka (joint ventures).

Dr. Mahmoud Mohieldin, aptly noted: "Islamic finance has the potential to bridge financing gaps in infrastructure development and support sustainable economic growth through ethical and equitable financial practices." This is precisely the role that Islamic finance can play in Ethiopia, where infrastructure development and sustainability are urgent needs.

In Ethiopia, where 34% of the population remains financially excluded, according to the World Bank's Global Findex Report (2021), this model presents an opportunity to bring marginalized communities into the financial fold. But the challenge lies in moving beyond theoretical ideals to genuine implementation.

I recently visited one of Ethiopia’s emerging Islamic banks and spoke with a young entrepreneur who sought financing for his agribusiness startup. Despite the bank's promise of interest-free financing, he found himself navigating complex Murabaha (cost-plus financing) agreements that felt eerily similar to conventional loans.

This is a common scenario in Ethiopia’s Islamic finance landscape. While the sector has made significant progress with four full-fledged Islamic banks and multiple Islamic windows, the gap between genuine profit-and-loss sharing models and conventional practices remains wide.

Many Islamic financial institutions, instead of embracing risk-sharing partnerships like Mudaraba and Musharaka, resort to debt-based instruments that mimic conventional loans. This is not due to a lack of will but rather regulatory constraints, limited expertise, and a risk-averse financial environment.

Ethiopia's nascent Islamic finance sector operates within a regulatory framework designed for conventional banking. This creates several structural barriers:

• Absence of a Sukuk (Islamic bonds) framework, which limits access to large-scale infrastructure financing.

• No clear tax guidelines for Islamic financial products, leading to double taxation on asset-backed transactions like Murabaha.

• Limited support for equity-based financing models, discouraging banks from engaging in true profit-and-loss sharing partnerships.

The irony is that while Ethiopia has launched its capital market through the Ethiopian Securities Exchange (ESX), Islamic finance is yet to be integrated into this historic transformation. Imagine the potential if Ethiopia could issue Sukuk to finance renewable energy projects, rural infrastructure, or agricultural ventures. Dr. Sami Al-Suwailem, Director General of the Islamic Development Bank Institute, noted: "The risk-sharing principle of Islamic finance provides a stable foundation for economic growth, particularly in emerging markets like Ethiopia, where capital markets are developing."

I often reflect on Malaysia’s journey. In the early 1990s, Malaysia faced similar challenges in integrating Islamic finance into its national economy. By establishing a dedicated Islamic finance regulatory framework, providing tax incentives for Sharia-compliant products, and training financial professionals, Malaysia became a global leader in Islamic finance.

Similarly, Indonesia leveraged Islamic microfinance to empower rural communities, while Turkey integrated Islamic finance into its capital market, allowing for Sukuk issuance and equity-based partnerships. These countries didn’t just create Islamic banks; they built an ecosystem that supports innovation, financial inclusion, and ethical investment. Ethiopia can follow this path, but we need bold regulatory reforms and capacity-building initiatives.

As Ethiopia’s securities exchange recently became operational, the opportunity to position Islamic finance at the center of capital market development is unprecedented. Imagine a scenario where Sukuk are issued to finance solar energy projects in rural areas like Raaso, or Musharaka-based investment funds support small-scale farmers and pastoralists.

This isn’t wishful thinking. Countries like Saudi Arabia and the UAE have successfully used Islamic bonds to finance mega projects, while also attracting international investors seeking ethical alternatives. Dr. Umar Moghul, an Islamic finance lawyer and author, emphasized: "Sukuk bonds can be a transformative tool for funding infrastructure and renewable energy projects while adhering to Sharia-compliant principles."

Ethiopia’s Securities Exchange Proclamation (2021) already provides a foundation for alternative financing instruments. By integrating Sharia-compliant regulatory frameworks and tax incentives, Ethiopia can attract billions in Islamic investment capital while creating jobs and boosting local development.

A Call for Policy Transformation

To unlock the full potential of Islamic finance, Ethiopia must:

• Develop a comprehensive Islamic finance regulatory framework, including laws for Sukuk, Islamic microfinance, and Takaful (Islamic insurance).

• Establish a dedicated Sharia Supervisory Board to ensure compliance and innovation.

• Offer tax incentives for Sharia-compliant financial products, eliminating double taxation on asset-backed transactions.

• Promote Islamic microfinance for rural communities, empowering small farmers and entrepreneurs.

• Build local capacity through Islamic finance training programs for banking professionals and regulators.

Islamic finance isn’t just about avoiding interest; it’s about creating equitable partnerships, fostering innovation, and empowering local communities. Ethiopia has taken the first steps with the establishment of Islamic banks, but to fully harness the power of Islamic finance, we must move beyond conventional practices and embrace genuine risk-sharing models.

The emergence of Ethiopia’s capital market, the growing demand for ethical finance, and the global rise of Islamic finance present a unique opportunity. If Ethiopia gets it right, Islamic finance could become a key driver of economic growth, job creation, and local development, especially in underserved regions.

As I reflect on that conversation with the elderly businessman in Addis, I realize that what he longed for wasn’t just an interest-free banking system—it was a financial system rooted in justice, fairness, and shared prosperity. And perhaps, through Islamic finance, Ethiopia can finally deliver that vision.