Ethiopia Moves to Put Interest-Free Finance on Equal Footing With Conventional Banking

Proposed national strategy targets tax neutrality, Sukuk, Sharia oversight and a pathway for large banking windows to become full-fledged institutions

Ethiopia is preparing a new regulatory framework for interest-free finance that could reshape competition between Sharia-compliant and conventional banking, with proposals for tax neutrality, Sukuk issuance and national Sharia oversight at the centre of the strategy.

The National Bank of Ethiopia (NBE) and Financial Sector Deepening Ethiopia are finalising the National Interest-Free Finance Strategy, a long-term framework designed to bring regulation in line with the rapid expansion of interest-free financial services.

The strategy is also expected to establish a pathway for sufficiently large interest-free banking windows operated by conventional banks to transition into full-fledged interest-free banks.

The NBE has previously identified interest-free finance as an important component of financial inclusion and financial-sector diversification. In May, the central bank held a validation workshop for the national strategy, calling for stronger coordination, clearer implementation priorities and a regulatory roadmap covering governance, Sharia compliance, risk management and institutional capacity.

A Fast-Growing Segment

Interest-free banking has expanded rapidly across Ethiopia’s banking system.

NBE data show that 23 of the country’s 31 commercial banks provide interest-free banking services. Four operate as full-fledged interest-free banks, while 19 provide the services through dedicated windows within conventional banks.

Industry data cited during the strategy process put interest-free deposits at around 331 billion Br as of March 2025, held across roughly 26 million accounts, while outstanding interest-free financing stood at about 151 billion Br.

The market is heavily concentrated. The state-owned Commercial Bank of Ethiopia reportedly held 172.3 billion Br in interest-free deposits, exceeding the combined 158.8 billion Br held by private banks.

Bank of Abyssinia has also expanded aggressively in the segment, reporting 41.7 billion Br in interest-free deposits from more than 2.2 million customers as of April 30, 2026.

The scale of the market is increasingly forcing regulators to address a question that has become central to the sector: should large interest-free windows remain inside conventional banks indefinitely, or should they eventually become independent institutions?

Tax Neutrality at the Centre of the Reform

One of the strategy’s major proposals is to establish tax neutrality between conventional and Sharia-compliant financing.

Unlike conventional lending, where financing costs are generally structured around interest, Islamic financing can use mechanisms such as mark-ups, asset sales and service charges.

Under the existing tax framework, these structures may not always receive treatment equivalent to conventional interest expenses. This can create different tax outcomes even when two financing arrangements serve the same economic purpose.

The proposed reforms would seek to ensure that customers are not disadvantaged simply because they choose an interest-free financing structure.

The objective is to put the two systems on a more comparable legal and tax footing rather than giving one model a structural advantage over the other.

Sukuk Could Open a New Investment Channel

The strategy also proposes the development of Sukuk, Sharia-compliant securities that could provide interest-free financial institutions with an alternative to conventional government securities.

This is particularly significant for liquidity management.

Conventional banks can invest excess liquidity in interest-bearing instruments such as Treasury bills and government bonds. Interest-free institutions, however, require Sharia-compliant alternatives.

The proposed framework would therefore enable the government to develop Sharia-compliant Treasury instruments, while also creating investment opportunities for institutions such as Ethiopian Investment Holdings and pension funds.

The strategy also envisions instruments that could help interest-free banks manage liquidity more effectively.

The need for such infrastructure has become more visible as interest-free banks expand. Hijra Bank, for example, has previously highlighted the absence of Sukuk as a structural constraint because conventional interest-bearing securities are not compatible with its operating model.

One National Sharia Framework

Another major proposal is the establishment of a National Sharia Supervisory Board.

Currently, individual institutions can rely on their own Sharia advisory structures. The proposed national framework would introduce a higher-level body capable of establishing common interpretations and standards for Sharia-compliant financial products.

The aim is to reduce differences in how banks interpret and implement Sharia requirements while strengthening compliance and consumer confidence.

The NBE has separately announced moves toward a central Shariah advisory structure, describing it as a step toward a unified governance framework for Sharia-compliant financial services.

The proposed national structure could also become increasingly important as new products, digital services and capital-market instruments enter the market.

Large Windows Could Face a Path to Conversion

The proposed strategy could also alter the competitive landscape between full-fledged interest-free banks and interest-free windows operated by conventional lenders.

Full-fledged banks have argued that windows benefit from the infrastructure, capital, technology and branch networks of their conventional parent institutions.

A window can therefore expand its interest-free business without having to build an entirely separate institution from scratch.

The strategy recognises windows as a legitimate transitional model but proposes that sufficiently large operations could eventually be required to transition into full-fledged interest-free banks.

No fixed threshold has yet been established. Instead, the NBE would determine the threshold according to market conditions and could revise it as the sector develops.

This could create a new competitive dynamic between standalone interest-free banks and the increasingly large interest-free businesses operated by conventional banks.

A Dual Banking System

The broader direction of the strategy is toward a dual financial system, where conventional and interest-free institutions operate alongside one another under comparable regulatory principles.

The NBE has publicly described interest-free finance as part of a more diverse and inclusive financial system and has stressed the need for stronger coordination, regulation and long-term strategic direction.

The strategy goes beyond commercial banks, with proposals covering interest-free microfinance, digital financial services, development finance and dedicated data collection.

A dedicated Interest-Free Finance Unit is also proposed within the NBE to strengthen regulatory capacity and expertise in Sharia-compliant contracts, risk management and fund segregation.

Implementation Could Take Years

Despite the breadth of the proposed reforms, implementation is expected to take time.

Participants have discussed a potential three-to-five-year implementation period, raising concerns about whether the regulatory framework can move quickly enough to keep pace with the sector’s expansion.

The NBE has stressed that the final strategy needs clear milestones, responsible institutions, measurable indicators, and realistic implementation priorities.

The challenge now is moving from broad policy support to an operating framework that can determine how interest-free banks compete, how windows transition, how Sukuk markets develop and how Sharia compliance is governed across the financial system.

If implemented as proposed, the strategy would represent more than a regulatory update for Islamic banking. It could establish the institutional architecture for a parallel interest-free financial ecosystem in Ethiopia, bringing banking, taxation, capital markets, microfinance and Sharia governance into a single framework.

Source: Addis Fortune