Implementation of interest free banking services in Ethiopia. The mediating role of customer involvement

Table of Contents

CHAPTER ONE
1. INTRODUCTION
1.1 Background of the study
1.2 Statement of the Problem
1.3 Objectives of the study
1.3.1 General objective
1.3.2 Specific objective
1.4 Research Questions
1.5 Scope of the study
1.6 Significance of the study
1.7 Limitation of the Study
1.8 Operational Definitions
1.9 Organization of the Study

CHAPTER TWO
2. REVIEW OF RELATED LITERATURE
2.1 Theoretical literature Review
2.1.1 General concepts and definition
2.1.2 Evolution of Theories and Models of Adoption
2.1.2.1 Fishbein`s multiattribute model
2.1.2.2 Theory of Reasoned Action
2.1.2.3 The Social Cognitive Theory
2.1.2.4 Technical Adoption Model
2.1.2.5 Theory of Planned Behavior
2.1.2.6 The Model of PC Utilization
2.1.2.7 The Motivation Model
2.1.2.8 Task-technology Fit
2.1.2.9 Decomposed Theory of Planned Behavior
2.1.2.10 Innovation Diffusion Theory
2.1.2.11 Extended TAM2 model
2.1.2.12 Unified Theory of Acceptance and Use of Technology
2.1.3 Comparison of the Models
2.1.4 Justification of model selected
2.2 Empirical Literature Review
2.2.1 Origin, Evolution and Growth of Islamic Banking
2.2.2 Underlying Principles of Interest-free Banking
2.2.2.1.. The IFB Business is based on Islamic (Sharia) Law
2.2.2.2. Paying or Receiving Interest (Riba) Is Forbidden (Haram)
2.2.2.3.. Utmost Fairness in All Business Dealings
2.2.2.4 Transparency, Consensus and Contractual Agreement between Parties in All Business Dealings
2.2.2.5.. Profit-and-loss Sharing
2.2.2.6. Forbidden (Haram) Business Activities
2.2.3 Islamic and Conventional Banking
2.2.4 Empirical Review at International Level
2.2.5 Empirical Review at National level
2.3 Research Gap
2.4 Conceptual Framework and Hypothesis Development
2.4.1 Conceptual Framework
2.4.2 Hypothesis Development
2.4.2.1.. The Proposed Research Model

CHAPTER THREE
3. RESEARCH METHODOLOGY
3.1 Research Purpose
3.2 Research Design
3.3 Data Source
3.4 Study Area/Organization
3.5 Target population
3.6 Sampling methods and sample size
3.6.1.. Sampling Methods
3.6.2.. Sample Size Determination
3.6.3 Branch Sample Size
3.7 Data Collection Method
3.7.1.. Primary Data Collection
3.7.2... Secondary Information
3.8 Data Analysis
3.9 Model Specification
3.10 Measurement of Constructs
3.11 Ethical Considerations

CHAPTER FOUR
4. RESEARCH FINDINGS AND DISCUSSIONS
4.1 sample and response rate
4.2 Questionnaire Pilot Testing
4.2.1. Validity
4.2.2.. Reliability
4.3 Descriptive Analysis
4.4 Demographic Information of the Respondents
4.5 Data Analysis: Assessing the Quality of Data
4.5.1. Assessing the Sample Size
4.5.2... Assessing Common Method Bias
Table 4.5.2-1: Total Variance Explained
4.5.3 Assessing Missing Data
4.5.4.. Assessing the Outliers
4.5.5 Assessing Linearity Assumption
4.5.6.. Assessing Multicolinearity Assumption
4.5.7... Assessing Normality Assumption
4.6 Data Analysis: Factor Analysis
4.6.1... Exploratory Factor Analysis (EFA)
4.6.2.. Confirmatory Factor Analysis
4.6.2.1 Measurement Model
4.6.2.1.1 Construct Validity
4.6.2.1.2 Convergent Validity
4.6.2.1.3 Discriminant validity
4.6.2.1.4 Nomological Validity
4.6.2.1.5 Goodness of Fit
Table 4.6.2.1.5-2: Proposed Latent variables and Indicators for EFA
4.6.2.1.6 Final Reliability
4.6.2.2 Structural Model
4.7 Discussions Of Empirical Findings

CHAPTER FIVE
5 SUMMARY OF THE FINDINGS, CONCLUSIONS AND Implication of the study
5.2 Summary of the study
5.3 Conclusion
5.4 Implications of the Study
5.5 Contribution
5.6 Limitation & Future Area of the Study

LIST OF REFERENCES

Appendix A
Questionnaire English

Appendix B-: Valid Questionnaire English

Appendix C: Table of Missing Data Procedure Findings Based on Frequency Distribution

APPENDIX D: Test for Communalities

Appendix E: Number of Sample IFB offering Branches from each Addis Ababa district

Appendix F: List of Banks Lounching IFB service

ACKNOWLEDGEMENTS

First, I would like to thank the almighty God for he gave me health, strength and patience to withstand the inconveniencies, which I came across through all the lines of life.

I would like to extend my heartfelt thanks to my advisor Dr. Yitbarek Takele (Associate Professor) for his valuable advice, insight and guidance starting from proposal development to the completion of the research work. He worked hard to keep me on the right track and timely accomplishment of the study.

I would like to express my deepest appreciation to my friends Abraham Redi, Andualem Gizaw, Omer Mohammed and Alem Wondimu their all rounded support and motivation. I also to extend my special gratitude to all the enumerators especially Anwar Abdela who assisted me in data collection with patience, commitment and dedication. Their cooperation was not on the basis of their material benefit but is really their own commitment to help me. Moreover, my colleagues at IFB and AAU deserve a special appreciation for their comments.

On the other hand, a group-wise acknowledgement is forwarded to all references used in this thesis.

Last but not least, my gratitude goes to my family members for their unprecedented support across the whole of my study in general and the research thesis in particular, with special thanks to W/ro. Marta Tesfaye and my two daughters: Kebron Nobel and Yohanna Nobel.

Peace, love and blessings

Thank you all!

Abstract

Purpose – The purpose of this paper is to investigate major factors affecting the implementation of Interest free banking services among customers in recognizing factors that need consideration in implimenting IFB service in Commercial Bank of Ethiopia, Addis Ababa, Ethiopia .

Design/methodology/approach- The research used innovation diffusion theory to investigate factors affecting implimenation of IFB services in doing so it integrates customer involvement and religious belifs modifying Rogers Model to investigate its effect robustly. Both primery and secondary data were used. Simple random sampling was used to solicit response from selected 366 respondents. The study used standardized questionnaire on selected branches of CBE in Addis Ababa, Ethiopia. The study employed exploratory and confirmatory factor analyses. An exploratory factor analysis was conducted using principal component analysis while confirmatory factor analysis was conducted using structural equation modeling techniques that fulfills measurement construct validity (both convergent and discriminant validity) and reliability through AMOS version 23 software.

Findings- Results showed that, except relative advantage, all the other variables: Awareness, compatibility, complexity, observability, perceived risk, religious beliefs and customer involvement were significant on the implementation of IFB services. Moreover, the finding indicated customer involvemet mediates the relationship between compatibility, complexity and perceived risk on implementation of IFB service. On the other hand, religious belifs moderates the relationshipship between compatibility, complexity, observability and perceived risk on implementation of IFB service.

Research limitations/implications- The study area was limited to Addis Ababa districts of CBE. Thus the results from this case might not be generalized to customers of other banks and to customers of CBE out of Addis Ababa districts. Furthermore, this study could not observe variable extensively due to the short tenure of the services implimentation which makes it difficult to get adequate references that has similar scope in the subject.

Social implications- This Study suggested the importance for bank providers to understand factors influencing implementation of IFB service, customers’ preference and view from the customers’ perspective, in order to attract and retain customers, as well as leop forward.

Originality/value- Upon validating the framework, findings from the study provides useful insight and especially first hand information on the role of customer involvement. That would be useful to the providers in gaining and retaining the existing customer, and to the policy makers, regulators and other relevant stakeholders to strategize inaccordance with their respective roles towards development and sustainment of the industry.

Keywords: IFB, IDT, religious belief, customer involvement,

List of Tables

Table 2.2.3-1: The difference between Islamic and conventional Banking

Table 2.2.4-1: summery of four areas of studies with IDT

Table 3.6.3-1: Sample size determination

Table 3.6.3-2: Number of Sample IFB offering Branches from Each District

Table 3.6.3-3: Number of Sample IFB - Customers from Each Addis Ababa districts

Table 3.6.3-4: Summery of the proposed Sampling Unit, Sample Size Determination and Sampling Techniques

Table 3.10-1: Conceptual Definition of Constructs

Table 4.2.2-1: Cronbach’s alpha reliability coefficient

Table 4.2.2-2: Instruement Reliability

Table 4.4-1: Summarizes the demographic profile of the respondents

Table 4.5.2-1: Total Variance Exolained

Table 4.5.6-1: Statistic for Multicollinierity test

Table 4.5.7-1: Normality of data distribution

Table 4.6.1-1: KMO and Bartlett's Test

Table 4.6.1.4-1: Rotated Facor Loading

Table 4.6.2.1.5-1: An Illustration of Recommanded cutoff value of Indices from AMOS

Table 4.6.2.1.5-2: Proposed Latent Variables and indicators of EFA

Table 4.6.2.1.5-3: Statistics for Proposed CFA Measurement Model

Table 4.6.2.1.5-4: Statistics of Discriminant Validity proposed measurement

Table 4.6.2.1.5-5: Statistics of Modification Indices for CFA measurement model

Table 4.6.2.1.5-6: Statistics of Final CFA measurement model

Table 4.6.2.1.5-7: Statistics of Discriminant Validity of Final measurement model

Table 4.6.2.1.6-1: Instrument Reliabilty

Table 4.6.2.2-1: Model Fit Statistics for Structural Model

Table 4.6.2.2-2: Regression Weight

Table 4.6.2.2-3: Direct effect of the Revised model

Table 4.7-1: The Summery of Mediation Estimates

Table 4.7-2: The Summery of Moderation Estimates

List of Figures

Figure 2.1.2.2-1 : Theory of Reasoned Action

Figure 2.1.2.4-1 Technology Acceptance Model

Figure 2.1.2.5-1: Theory of Planned Behavior

Figure 2.1.2.6-1: The Model of PC Utilization

Figure 2.1.2.8-1: Task-technology Fit

Figure 2.1.2.10-1: Innovation Diffusion Theory

Figure 2.1.2.11-1: Extended Technical Adoption Model

Figure 2.1.2.12-1: The UTAUT Model

Figure 2.2.1-1: Historical Emergence of Interest-Free Banks

Figure 2.4.1-1 Schematic Diagram modified IDT conceptual framework showing relationships between variables

Figure 4.6.2-1: The process of SEM results

Figure 4.6.2.1.5-1: CFA results of the proposed CFA Measurement Model

Figure 4.6.2.1.5-2: The Re-Specified Structural Model and Final CFA Measurement model

Figure 4.6.2.2-1: Structural Model

Figure 4.7-1: Hypothesis Testing of the Mediational of CINN

List of Acronyms

The researcher would also like to outline the interpretations of the acronyms used in the proposal and the prospective report;

AAOIFI: Accounting and Auditing Organization for Islamic Financial Institutions

AMOS: Analysis of Moment Structure

ATM: Automated Teller Machine

BBP: Banking Business Proclamation

CBE: Commercial Bank of Ethiopia

DTPB: Decomposed Theory of Planned Behavior

IDT: Innovation Diffusion Theory

IFB: Interest Free Banking

IFBWS: Interest Free Banking Window Service

IFSB: The International Financial Services Board

MIS: Management Information System

NBE: National Bank of Ethiopia

PC: Personal Computer

SCT: Social Cognitive theory

SEM: Structural Equation Modeling

SPSS: Statistical Package for the Social Sciences

TAM: Technological Acceptance Model

TPB: Theory of Planned Behavior

TRA: Theory of Reasoned Action

TTF: Task Technological Fit

UTAUT: Unified Theory of Acceptance and Use of Technology

CHAPTER ONE

1. INTRODUCTION

Islamic banking is a rapidly growing sector within global banking industry that has become systemically essential in a 75 countries over 300 Islamic financial operating in a varied range of regions (Hearn, Piesse, & Strange, 2012). It is projected to continue to increase in response to economic growth in countries with considerable and relatively unbanked Muslim populations. Islamic banking is one of the most rising trends in the global economies is the idea of Interest free banking and Finance (Ahmad, 2000), that emerged in the global landscape as an alternative banking system which is in line with values and ethos of Islam, and governed by the principles of Sharia Law (Gait and Worthington, 2008).

Interest free banking is inseparable of Islamic economics which aimed at realization of a greater justice in human endeavor, which is achievable only with participation of all human institution inclusive of financial system (Adeniran, 2013). On the principle that prohibits interest and other unethical and non shariah compliant activities, Islamic banking set to achieve this gigantic objective. In addition, it strive on increasing all Halal aspect of business through provision of products and services base on shariah principle with implementation of legitimate profit and loss sharing, paying Zakah, prohibition of interest, monopoly and other forms of unethical trade and transaction such as dealing with pork, alcohol and gambling (Ayub, 2007; Gait & Worthington, 2008; Sanusi, 2012). Hence, Islamic banking method of financing and or products structure is based on the tract to redress the inherent injustice tied with interest based dealing. These principles, albeit paving the way to achieving social economic progress in the society (Metawa & Almossawi, 1998) have also provided an alternative mode of finances capable of competitively breaking the long established monopolistic position posed by conventional financial system (Aliyu, 2012; Gumel & Othman, 2013).

The reality of Islamic banking emergence as an alternative to conventional banking, and its contribution in propelling the development of the global economy has been proven in the international financial outlook (Tahir, Bakar, Ismail, & Wan, 2006). According to Fakhrul- Ahsan (1998) and Usman (2003), the role and functions of Islamic banking within the banking system in a modern economy are very important, and in fact, it is at the heart of every robust economy. For the fast four decade, Islamic banking sector has grown in a large scale with a double digit annual growth rate and recently by almost 20 percent (Rustam, Bibi, Zaman, & Rustam, 2011). The institution has witnessed an unprecedented expansion and its effect was observable within the Muslims countries and has extended to all nooks and crannies of the globe. Loo, (2010) and Perry & Rehman (2011) observed that the Institution gained momentum and world recognition for its resistance to the global financial crisis that mars the major financial players of the world. This gave the Islamic finance industry opportunity to widen its horizon to new investors (Quadri, 2011). And hence penetrated the western countries where their presence is also remarkable. For instance, in Denmark, United Kingdom, and USA, and in Luxembourg Islamic banking was in operation since 1978 (Perry & Rehman, 2011). The number of Islamic financial institutions is at rise and established in more than 75 countries (Ayub, 2007; Fatai, 2012; Khan & Bhatti, 2008).As at 2005, the total assets managed under the Islamic banks were $500 billion this figure rose to $700 billion two years later in 2007. The growth of Islamic finance was estimated at $1.8 trillion in 2013 and presently anticipated to hit over $2.2 trillion by the end of 2016(Muslimmirrow.com, 2017). Being the core of the Islamic financial system, and also accounting for 80 percent of its total assets, Islamic banking sector’s assets are expected to exceed $3.8 trillion by the end of 2022 (Saudigazette.com, 2017). Islamic banks were indeed successful in the provision of innovative products and services to their customers irrespective of their faith.

For its noticeable achievements, Islamic banking has become attractive so much that many countries are yarning and or struggling to have it in operation like the case of Ethiopian from sub-Saharan Africa that have just embraced and started enjoying the system. Being it a newly established phenomenon, the interest free banking in Ethiopia needs to be steady and prepared to compete with the historically dominance conventional commercial banks that are in existence for almost a century. According to the 2007 national census, the Muslim population comprises 33.9% of the total population in Ethiopia CSA (2018), offers the opportunity for substantial customers that would patronize Islamic banking products. As such investigating the factors affecting the implementation of the Interest free banking products and services in the country is paramount and timely.

1.1 Background of the study

In Ethiopia, numbers of citizens that have bank accounts are not more than 9% of the population in 2012. Lower access to formal financial services among others stem from people’s culture and belief. Responding to a strong public demand, the National Bank of Ethiopia (NBE) was expected to approve a directive that paves the way for the establishment of what was deemed as the first Islamic bank in Ethiopia. A circulated draft of the NBE directive has allowed Ethiopian nationals to establish a bank exclusively engaged in interest-free banking,” however, that hope was short living as the finally issued directive does not allow the establishment of full-fledged Islamic financial institution. The final directive has only opened the door for “existing commercial banks” to create an interest-free banking window (Mohammed, 2012).

As per the Directives of National Bank of Ethiopia SBB/51/2011, all commercial banks that are licensed to engage in the Conventional Banking Business are privileged to engage in Interest Free Banking (IFB) business through the existing branch offices only after securing independent license for running the business, which is subject to fulfillment of some 10 to 11 terms and conditions set out thereof, among others, the directive also orders banks not to go past the maximum share of interest-free banking business in their consolidated balance sheet without prior approval from the National Bank. A violation of this could lead to the closure of an interest-free banking window. Preparation of separate financial reports, keeping all data and ensuring the segregation of activities from conventional banking are also some of the requirements set by the directive.

Subsequent to the issuance of the working directive, the NBE has granted the IFB service license to Oromia International Bank S.C on September 16, 2013. Same license is granted to the Commercial Bank of Ethiopia on September 17, 2013. Accordingly CBE using its 23 pilot branches and OIB using its 24 branch offices launched IFB operation on October 24, 2013 and December 16, 2013 respectively. On May 1, 2014, United Bank S.C. began providing IFB service and recently, Cooperative Bank of Oromia, Nib International Bank, Abay Bank and Wegagen Bank have joined the IFB business by giving depository products for the time being. However, Initially, Zemzem, a prospective new bank, requested to join the banking industry as a full-fledged interest-free bank, was unable to start operations as the directive requires that interest-free banking be given alongside conventional banking services. As per Senait, (2015) Zemzem Bank was floating shares with the sole intention of operating interest-free banking, since December 2010. It was able to raise 137 million Br in paid-up capital and 337 million Br in subscribed capital from 6,800 shareholders.

Thus, currently, there is no bank which gives full-fledged IFB banking services in Ethiopia as the regulatory organ has only allowed the existing conventional banks, to give the services through separate windows.

1.2 Statement of the Problem

The empirical evidence shows that Interest free banking have rapidly spreading and developing across the world. Some factors appear to be correlated with the diffusion of IFB, namely the principles of risk-sharing that underlie financing, the growth of oil-rich economies, the presence of Muslims in the population, an enabling legal framework, and economic integration with Middle Eastern countries or proximity to Islamic financial centers (Alam, et al 2011). Wherever there is a sizable Muslim community and is not restricted to Muslim countries, the probability for Islamic banking to spread in a given country rises with the share of the Muslim population. According to Ibrahim (2012), trading with the Middle East and economic stability are also conducive to the diffusion of Islamic banking.

Almost half of Ethiopian banking commercial industry out of eithteen banks has commenced Interest free banking service within less than three years while some others banks are also showed initiation to commence it. The rapid diffusion of interest free banking adoption by banking organization reflects their understanding of the importance and untapped demand it is as an alternative financing intermediary in stiff banking competition. In return, banking sectors investigation of factors influencing customers’ behavioral intention to adopt interest free banking product and service, identifying resistance to adoption for product modification and frequently collecting feedback can help banks to mobilize significant amount of deposit thereby divert to financing that can create active economic circulation. Besides, interest-free banking deposit market share is very low compared to conventional banks deposit & Customer Base; banks are increasingly making an effort to attract customers by through awareness campaign to attract potential customers .Islamic banking studies are largely conducted in Muslim ccountiries and to a smaller extent among non-Muslims countries. Studies in Ethiopia on IFB have been very few due to the infancy of the industry. Studies in Ethiopia include; Mohammed (2012) has identified the potential challenges of IFB before commencement of the service. This study was undertaken before the practical introduction of the IFB in the country. Therefore, it was not based on actual observation of facts on the ground. While, Teferi (2015) has identified that introduction of IFB does not only create inclusive financial system for the Muslim population but also has a potential to influence and enhance the economic development of the country through resource mobilization and employment creation by encouraging people to use the banking system. It is only limited to IFB’s contribution and prospects. On the other hand, there is a work on Customer’s Intention (Debebe A., 2015), but the study was based on the model of Decomposed Theory of Planned Behavior (DTPB).

Besides few research has been limited to the Prospect and challenges of introducing Interest free Banking in Ethiopia‟(Mohamed, 2012; Akmel, 2015; & Kerima, 2016), Their work has identified the potential challenges as: lack of awareness, regulatory and supervisory challenges, institutional challenges, lack of support and link institutions, gap in research and development in Islamic studies, lack of qualified human resource as well as wrongful association with specific religion and the global terrorism & targeting only bank officials and bank employees as a study population which excluded customers’ domain.

Abraham (2017) has conducted a study on Determinants of Customers’ Intention to Use Interest Free Banking Products and Factors Affecting Employees’ Product Knowledge, the study on customers’ intention contributes towards a better understanding of the customers’ expectation. The management of the bank can now comprehend better the factors that effect customers’ decision in adopting IFB in order to intensive marketing strategies to attract customers. On the other hand, the study on employees’ product knowledge suggests that the bank should train well its employees in order to cope with the current dynamics of the banking industry.

To best of my knowledge, there is no earlier work in the country in context of Interest free banking which tries to model proper implementation of interest free banking service based on the Innovation Diffusion Theory (IDT). Additionally, the researcher modified this model by introducing two relevant factors: customer involvement and religious belief and also tested the mediating role of customer involvement and moderating effects of religious belief on implementation Of IFB services by employing Structural equation modeling (SEM).

At International level there are several empirical studies on Islamic banking and finance. The studies investigated several factors affecting the proper implementation faced by the Islamic banks in various contexts. Few of these studies are given below.

According to the findings of Tooraj Sadeghi et al (2011), Thambiah et al. (2012) Lukman et al (2012), Binta, et al (2014), Dariyoush, et al (2014), Akhtar et el (2016), Yahya, et al (2017) applies the Rogers diffusion model (2003) in the study IFB adoption is subject to Relative Advantage, Complexity, compatibility, Attitude, Behavioral intention, Actual Use, Social Influence, Religiosity and perceived behavioral control are found to have significant relationship with customers’ adoption of Islamic banking products and services.

Huang & Liu (2017) examined customer involvement mediates the relationship between brand equity and customer loyalty. The results had significant and positive relationship with customer loyalty, while customer involvement has partial indirect on customer loyalty in path analysis. Conterary a study conducted by Johra Fatima (2013) investigates different roles (antecedent, mediator and moderator roles) of customer involvement in rapport and satisfaction. It is also designed to reveal the comparative effect of three types of relational benefits (confidential, social and special treatment benefits) on customer involvement. FindingsResults suggest that customer involvement does have antecedent and mediated effect on rapport-satisfaction link while the mederation effect of customer involvement is not supported. In contrast, social treatment benefit is found as the most important relational benefit for developing customer involvement.

The study conducted by Thambiah, et al (2013) examined the moderating of religious beliefs, difference against the intention to use Islamic Retail Banking (IRB) products and services .Thire study comprises of eight independent variables: Customer awareness of IRB, relative advantage, compatibility, complexity, uncertainty, observability, promotional efforts and perceived information quality. Their findings reveal religious reasons are still instrumental in influencing the intention to use IRB products and services to certain extend. Based on the findings, although, religion does not significantly moderates all the factors, obviously there seemed be a certain degree of interaction with customers’ perceived relative advantages, compatibility, complexity and the willingness to use IRB products and services. Conversely Kareem & Afiff (2006), Dusuki & Abdullah (2007) and Khattak & Rehman (2010) findings results suggest that religios belifs is not the main reason for people to support Islamic Banks.

At international level Researchers have identified and investigated several factors considered as relevant in influencing customers as well as attracting them towards the adoption of the products and services. These studies have revealed that though there are some determinant factors common to many countries, there are also factors which are unique to each country due to social, cultural, economical, technological, political, religion and other factors. Furthermore, the study environment of the international researches were on Moslem-dominated and or Arab countries; therefore, it could be difficult to implement policy recommendations of the respective researches directly in to the Ethiopian context. This, study, therefore, attempts to fill this research gap by investigating the major factors faced by service providers and users of IFB products and scope of service provided by Ethiopian banking through IFBW.

In nutshell, the strong interest of Commercial banks to commence IFB as alternative financing intermediary, existence of large Muslim community in the country versus low market share of IFB compared to Conventional banks, absence of literature on factors affecting implementation of IFB were the major area of this research Gap.

Therefore, early exploring factors affecting implementation of Interest Free Banking help all stakeholder of IFB to address the problem and speed up implementation of IFB product and service that has important contribution for economic development.

1.3 Objectives of the study

1.3.1 General objective

The general objective of conducting this research is to investigate and find out major factors affecting the implementation of Interest free banking window service and to recognize those factors that need more consideration to develop Interest free Banking in Ethiopian economy, with specific reference to Commercial bank of Ethiopia.

1.3.2 Specific objective

The specific objectives of the study were

- To determine the effect of awareness on implementation of interest free banking service.
- To find out how relative advantage affect the implementation of interest free banking service.
- To examine the association of compatibility with implementation of interest free banking service.
- To determine the effect of complexity on implementation of interest free banking service.
- To examine the relationship of observability with implementation of interest free banking service.
- To assess the relationship perceived risk has with implementation of interest free banking service.
- To assess the of customer involvement on implementation of interest free banking service.
- To determine the effect of religious belief on implementation of interest free banking service.

1.4 Research Questions

This study was an attempt to answer mainly the following research questions to achieve the intended objectives of the study and to address the research problem properly in accordance to with theory of Innovation Diffusion.

1. What are the key factors affecting the implementation of Interest Free Banking service in commercial Bank of Ethiopia?
2. Does customer involvement mediate the relationships between Key factors on implementation of IFB service?
3. Do religious beliefs moderate the relationships between Key factors on implementation of IFB service?

1.5 Scope of the study

Even though there are eighteen commercial banks in Ethiopia there are only eight commercial banks that have adopted interest free banking service as per own computation from secondary data (see Appendix F) and out of those commercial banks that are currently providing the service commercial bank of Ethiopia that comparatively found to have the large portion of interest free banking customers data is selected (see Appendix F). Therefore, Commercial Bank of Ethiopia that have adopted interest free banking service and that constitute 60% of the total IFB users in March 31, 2018 is selected.

1.6 Significance of the study

IFB is a relatively new business model in Ethiopian banking system. It is also growing in its applicability among Muslim as well as non-Muslim countries to accommodate the Muslim population, who otherwise, are excluded from financial services due to religion factor. It is believed that including this section of the population into financial service provision will expand the financial frontier and bring about economic benefit both to the country and the beneficiaries. It is, therefore, the results of this study will be significantly practical and helpful for;

- Policy Makers: It will give significant direction to review the current policy for the ive development of IFB activities in Ethiopia
- Practical: It will provide a road map for the Interest free banking and financial institutions by studying what criteria that significantly affecting the implementation on Interest free banking. Thus, the interest free banking and financial institutions will come out with a new strategy and strengthen their institutions. And the bank management as well as marketers to target their actions and strategies more ively can act upon this study to understand its gap (if any) and act upon it so that it meets its original purpose or reason of starting business. These individuals can help banks to implement new strategies or to readjust their existing strategies to tap the potential Interest free banking sector in Ethiopia.
- Theoretical: Finally, it will also serve as a reference material a good basis to carry out for subsequent research activities on IFB and related topics.

1.7 Limitation of the Study

The study area was limited to Addis Ababa districts of CBE. Thus the results from this case might not be generalized to customers of other banks and to customers of CBE out of Addis Ababa districts. The second limitation is lack of sufficient references due to the reccency of commencement of interest free banking service in Ethiopia.

Thus, to minimize the effect of the limitation encountered the researcher defined the scope properly and the inavailability of adequate scholarly work in the countries context were effectively delt with through use of relevant developing countries litreatures as well as consultation of the industry specialists in Ethiopia.

1.8 Operational Definitions

Considering the fact that the interest-free banking convention is an emerging concept in Ethiopian context, the researcher was introduce some important key terms and concepts used in the study along with their spirits and contexts for ease of understanding of the research subject.

- Gharar: Any act of uncertainty.
- Hadeeth; A report of the sayings or actions of Muhammad or his companions together with the tradition of its chain of transmission, or the collective body of these traditions.
- Haram: is a forbidden activity and is considered as a major sin. A haram activity is punishable by Allah, and avoidance of haram activities, such as gambling and drinking, is rewarding.
- Halal: Things permissible by the Sharia’
- Hawala: Remittance that involves a transfer of funds/debt from the depositor’s/ debtor’s account to the receiver’s/creditor’s account; a commission may be charged for the service.
- Ijaraha Financing: Lease financing.
- Istisna Financing: Building and plant construction financing.
- Mudharabah: (trust financing) is a partnership between a bank and a customer in which the bank provides the capital for a project and the customer or entrepreneur uses his or her expertise to manage the investment.
- Mudarib: Entrepreneurial manager in Mudharabah (trust financing) partnership.
- Murabaha Financing: Working capital financing on a cost plus a profit margin basis.
- Musharakah/Musyarakah: (partnership financing) refers to an investment partnership in which all partners share in a project‟s profits on the basis of a specified ratio but losses are shared in proportion to the amount of capital invested.
- Prohibition: business engagements forbidden in compliance with the Sharia Principle.
- Qarad: Interest-free financing.
- Restricted Investment Deposits: Deposits to be deployed for investment by the bank for economical financing based on the recommendation of the depositor customer.
- Riba/Usury: Interest.
- Salam Financing: Agricultural products financing. Standalone: a banking convention operating independently.
- Sharia Committee: a team of an independent Sharia Scholars in charge of monitoring compliance aspect of the IFB.
- Sharia Principle: Islamic law.
- Sunna: The way of life prescribed in Islam, based on the teachings and practices of Muhammad and on exegesis of the Qur‟an, or Muhammad's way of life viewed as a model for Muslims.
- Unrestricted Investment Deposits: Pool of deposits to be independently deployed by the bank for any economical financing without any intervention of the depositor.
- Wadiah Deposit: Return-free safekeeping deposit.
- Wakalah: Agency service.

1.9 Organization of the Study

This study comprises of five chapters. In the first chapter, the back ground of the study, statement of the problem, significance of the study, scope and limitations of the study, general and specific objectives, research questions, hypothesis of the study and operational definitions were included. In the second chapter, reviews of theoretical and empirical literatures were incorporated. In the third chapter, the methodology part of the study is clearly detailed and in the fourth and fifth chapters the result & discussion and summary, conclusion & recommendations of the study were presented consecutively.

CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

Chapter two is structured along several themes. First section of the study is theoretical literature review, explains, the general concepts and definition of interest free banking and theory and models for adoption, comparisons of the model and finally justification of the model used are discussed. Second, Empirical literatures which provides insight into origin evolution & growth and principles of Islamic banking, Islamic and conventional banking are described. Innovation Diffusion Theory and their constructs are discussed to develop a research model to help investigate factors affecting the implementation of Interest free banking service in Addis Ababa, Ethiopia.

2.1 Theoretical literature Review

1

2.1.1 General concepts and definition

The term “Interest Free/Islamic banking” has no single definition. Many scholars‟ gives various meaning to this term Islamic banking. It refers to a system of banking or banking activity that is consistent with the principles of the Shari'ah (Islamic rulings) and its practical application through the development of Islamic economics. The principles which emphasize moral and ethical values in all dealings have wide universal appeal. Shari'ah prohibits the payment or acceptance of interest charges for the lending and accepting of money, as well as carrying out trade and other activities that provide goods or services considered contrary to its principles. While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to provide an alternative basis to Muslims although Islamic banking is not restricted to Muslims. (www.islamic-banking.com).

According to Kamarulzaman & Madun (2013) defined Islamic banking is a system of banking or banking activity that is consistent with the Principles of Islamic Law (Sharia). Sharia prohibits interest charged on loans, the practice of giving or accepting additional money for money that is borrowed and the business involved directly or indirectly in alcoholic drinks, gambling-related business, or any type of business that is considered harmful or that could cause disruption to the welfare of the society.

The general secretariat of the Organization of the Islamic Conference, defines an “Islamic bank as a financial institution whose statutes, rules, and procedures expressly state its commitment to the principle of sharia and to the prohibiting of the receipt and payment of interest on any of its operation” (Ali and Sarkar 1995).

In Accordance with NBE’s Directive SBB/51/2011 “Interest Free Banking Business” refers a banking business in which mobilizing or advancing of funds taken in a manner consistent with Islamic Finance Principles and mode of operation that avoids receiving or paying interests.

“Implementation” refers Successful application of interest-free banking into a conventional system. The following four areas in particular have paramount importance. Compliance with Shari’ah, segregation of Interest-free and conventional funds, accounting standards, and awareness (Juan Sole, 2007).

2.1.2 Evolution of Theories and Models of Adoption

Theories provide a set of explanatory variables which can be used to predict a particular phenomenon. A model, on the other hand, is defined as a systematic description of a system, a theory or a phenomenon that accounts for its known or inferred properties which may be used for further study of its characteristics. Also a model is any abstract representation of some portion of the real world, constructed for the purpose of understanding, explaining, predicting or controlling a phenomenon being investigated (Burch 2003). A number of theories have proposed to explain consumers’ acceptance of new technologies and their intention to use. These included, but were not restricted to, the Fishbein`s multiattribute model (Fishbein's 1967), also called learning theory (Kassarjian & Robertson 1991), the Theory of Reasonable Action (TRA) (Fishbein and Ajzen, 1975), The Social Cognitive Theory (Bandura, 1986), Technical Adoption Model (Fred D Davis 1989), Theory of Planned Behavior (Ajzen, 1991), The Model of PC Utilization (Thompson et. al. 1991), Task-technology Fit ( Goodhue et al. 1995), Decomposed Theory of Planned Behavior (Taylor and Todd 1995), Extended TAM2 model (Venkatesh and Davis, 2000), Unified Theory of Acceptance and Use of Technology (Venkatesh, 2003).

2.1.2.1 Fishbein`s multiattribute model

Fishbein`s multiattribute model (Fishbein's 1967) suggests that a person’s attitude to any object/behaviour is based on individual’s belief about the object/behaviour and the evaluation of the object/behaviour. Attitude towards object/behaviour = ∑bi x ei, where: - bi is as belief component that expresses the probability that object/behaviour has a certain attribute i/consequence i. In other words, it is a belief that object possesses specific characteristics or that the behaviour has certain consequence. - ei is evaluation component associated with the attribute i/consequence i. This means the customer’s evaluation, liking or disliking, of the attribute i, or evaluation of the consequence of the behaviour.

2.1.2.2 Theory of Reasoned Action

Theory of reasoned action is an extension of Fishbein’s multiattribute model to account for the relationship between attitudes and behaviour. Theory of Reasoned Action (TRA) has its roots in social psychology setting. The theory proposes three general constructs, namely "behavioral intention, attitude and subjective norm". According to TRA behavioral intention of a person depends on his attitude and subjective norms. Mathematically, it can be interpreted that behavioral intention is the summation of attitude and subjective norms. Moreover, intention of a person likely to convert to action if there is the intention to behave in a specific manner is strong enough.TRA is intended to predict behaviour in situations where the customer controls his own behaviour and he is thoughtful about it. TRA states that the most important determinant of consumer actual behaviour is the intention to behave. The behavioural intention is affected by attitude towards behaviour and subjective norms, which are two new contributions to Fisbein’s previous model. Attitude to behave is defined as an individual’s positive or negative feelings about performing the target behaviour (Fishbein & Ajzen 1975).

Figure 2.1.2.2-1: Theory of Reasoned Action

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Source: Fishbein and Ajzen, (1975)

2.1.2.3 The Social Cognitive Theory

Focus of the Social Cognitive Theory developed by Bandura (1986) is on the concept of self-efficacy which is defined as "the judgment of one's ability to use a technology to accomplish a particular job or task" (Compeau and Higgins, 1995). According to SCT, behavior of the user is effectd by expectations of outcome related to personal as well as performance-related gains. Self-efficacy, in turn, effects the expectation of outcome of both types. While esteem of the person and his sense of achievement relate to personal outcome expectations, out-come expectations related to performance on the job lead to performance related expectations. According to SCT, there are two opposing factors that effect behavior of the users. Positive contribution is made by the factor "affect" which is the extent to which an individual likes his job. On the other hand, negative contribution to desired behavior is made by the factor "anxiety" which is the anxious reaction of the person while performing a job such as trying to use a computer with which the person is not very familiar. This theory has been widely used in adoption studies.

2.1.2.4 Technical Adoption Model

The model was originally developed by Fred D Davis (1989) in order to predict and measure user’s acceptance of computers. Davis Proposed two theoretical constructs, “Perceived Usefulness” and “Perceived Ease of Use”, which are theorized to be fundamental determinants of Information Technology use. He then studied the of these two constructs on actual information technology usage behavior of users (self-reported current usage and self-predicted future usage). TAM has been employed in itself or by incorporating it with other models in almost all kinds of researches related with technology adoption. Particularly, TAM is the common model for most researchers in the area of Electronic banking adoption. Based on two separate empirical studies conducted by Davis, he found out that “Perceived Usefulness” is significantly correlated with both self-reported current usage and self-predicted future usage. “Perceived Ease of Use” is also found to be correlated with current and future usage behavior (Davis, 1989,). Technology Acceptance Model (TAM) was introduced by Fred Davis in 1986 for his doctorate proposal as shown bellow. An adaptation of Theory of Reasonable Action, TAM is specifically tailored for modeling users’ acceptance of information systems or technologies.

Figure 2.1.2.4-1 Technology Acceptance Model

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Source: Davis (1989)

2.1.2.5 Theory of Planned Behavior

The Theory of Planned Behavior (TPB) was proposed by Icek Ajzen in 1991 and was developed from the Theory of Reasoned Action (TRA) which was pro-posed by Martin Fishbein and Ajzen in 1975. TPB adds the concept of Perceived Behavioral Control (PBC) to the constructs attitudes and subjective norms which make the TRA. Perceived behavioral control refers to "people's perception of the ease or difficulty of performing the behavior of interest". It differs from Rotter's (1966) concept of perceived locus of control because it is not constant and varies with different situations faced by the individual. Locus of control is considered to be a more generalized expectancy of the individual that remains fairly stable across situations. In this way, the criticism faced by TRA that it is based on relatively static construct of attitude and thus cannot be used for prediction of behavioral outcome has been addressed by TPB. The roots of concept of PBC are grounded in the Self-Efficacy Theory proposed by Bandura (1977) which in turn came from the Social Cognitive Theory. Bandura (1986) defined self-efficacy as "the judgments of how well one can execute courses of action required to deal with prospective situations". According to the theory, self-efficacy is the most important determinant for behavioral change since it leads to building up of coping behavior.

Figure 2.1.2.5-1: Theory of Planned Behavior

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Source: Ajzen (1991)

2.1.2.6 The Model of PC Utilization

The model is developed by Thompson et. al. (1991) based on the Theory of Human Behavior by Triandis (1977) which differs in some ways from the Theory of Reasoned Action because it makes a distinction between cognitive and affective components of attitudes. Beliefs belong to the cognitive component of attitudes. According to this theory "Behavior is determined by what people would like to do (attitudes), what they think they should do (social norms), what they have usually done (habits), and by the expected consequences of their behavior". This theory primarily deals with extent of utilization of a PC by a worker where the use is not mandated by the organization but is contingent on the option of the user. In such a setting, the theory posits that the use of computer by the worker is likely to be effectd by several factors such as his feelings (affect) toward using PCs, prevalent social norms regarding use of PC at the work-place, general habits related to use of the computer, consequences expected by the user by using the PC and extent of conditions that are present at the work place for facilitating use of PC.

Figure 2.1.2.6-1: The Model of PC Utilization

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Source: Thompson et al. (1991)

2.1.2.7 The Motivation Model

Davis applied the motivational theory to study information technology adoption and use. The main premise of the Motivation Model is that there are extrinsic and intrinsic motivations that shape the behavior of the user. Extrinsic motivation is defined as the perception that users want to perform an activity "because it is perceived to be instrumental in achieving valued outcomes that are distinct from the activity itself, such as improved job performance, pay, or promotions" (Davis et al., 1992). Examples of extrinsic motivation are perceived usefulness, perceived ease of use, and subjective norm. On the other hand, if performing an activity leads to a feeling of pleasure and results in satisfaction for the individual, such behavior can be classified as intrinsic motivation. (Vallerand, 1997). Users want to perform an activity "for no apparent reinforcement other than the process of performing the activity per se" (Davis et al., 1992).

2.1.2.8 Task-technology Fit

According to Goodhue et al. (1995), Task-technology Fit (TTF) emphasizes individual effect. Individual effect refers to improved efficiency, iveness, and/or higher quality. Goodhue et al. (1995) assumed that the good fit between task and technology is to increase the likelihood of utilization and also to increase the performance effect since the technology meets the task needs and wants of users more closely. As shown in Figure, this model is suitable for investigating the actual usage of the technology especially testing of new technology to get feedback. The task-technology fit is good for measuring the technology applications already release in the marketplace like in the Google play store or apple store app (iTunes) etc.

Figure 2.1.2.8-1: Task-technology Fit

Source: Goodhue and Thompson, (1995)

2.1.2.9 Decomposed Theory of Planned Behavior

Decomposed Theory of Planned Behavior (Decomposed TPB) was introduced by Taylor and Todd (1995). The Decomposed TPB consists of three main factors influencing behavior intention and actual behavior adoption which are attitude, subjective norms and perceived behavior control. Shih and Fang (2004) examined the adoption of internet banking by means of the TPB as well as Decomposed TPB.

2.1.2.10 Innovation Diffusion Theory

Everett M. Rogers, in his book titled “ Diffusion of Innovations” (1995), developed a model for Innovation-Decision process, Rogers defined this process as “ the process through which an individual (or other Decision making unit) passes from first knowledge of an innovation, to forming an attitude toward the innovation, to a Decision to adopt or reject, to implementation of the new idea, and to confirmation of this Decision” (Rogers, 1995).

Figure 2.1.2.10- 1: Innovation Diffusion Theory

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Source: Rogers (1995)

2.1.2.11 Extended TAM2 model

Venkatesh & Davis (2000) modified TAM to include additional key determinants of TAM's perceived usefulness and usage intention constructs in their extended TAM model. The additional constructs included social effect processes (subjective norm, voluntariness and image) and cognitive instrumental processes (job relevance, output quality, result demonstrability and perceived ease of use) which are depicted in Figure bellow.

Figure 2.1.2.11-1: Extended Technical Adoption Model

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Source: Venkatesh & Davis (2000)

2.1.2.12 Unified Theory of Acceptance and Use of Technology

This theory, popularly referred as UTAUT was postulated in 2003 by Venkatesh et.al. By a systematic review and consolidation of the constructs of earlier eight models (TRA, TAM, MM, TPB, TAM2, DOI, SCT and model of personal computer use). It is meant to serve as a comprehensive model that can be applied across a range of applications. It has four key constructs namely "performance expectancy, effort expectancy, social effect and facilitating conditions" which are depicted in Figure below.

Figure 2.1.2.12-1: The UTAUT Model

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Source: Venkatesh (2003)

2.1.3 Comparison of the Models

There has been a great deal of research on the Fishbein’s multiattribute model (Shiffman & Kanuk 1994; Onkvisit & Shaw 1994), Theory of Reasoned Action (Ajzen & Fishbein, 1980; Sheppard, Hartwick, and Warshaw, 1988) Theory of Planned Behavior (Ajzen, 1991) and Decomposed Theory of Planned Behaviour, (Taylor and Todd, 1995) but mostly used for products already in the marketplace and included the view of society (Subjective norm). An adaptation of Theory of Reasonable Action, TAM and UTAUT are specifically tailored for more popular technology acceptance theories/ models that are being used worldwide in different settings more especially in IS literature.

2.1.4 Justification of model selected

Islamic banking has emerged as a new reality in the global financial outlook since the 1970s (Tahir, Bakar, Ismail, & Wan, 2006).Behind any adoption process there must be something new, being it product (s) and or service, idea or way of doing things. This suggests that there could be existing product(s) initially and comes the need to improve it or switched to another one (new). Kotler (1994) posits that new products incorporate original products, products modification and products improvement. It also includes the products ready to be launched in to the market and those that are perceived as new in comparison to others by the potential adopters (Blackwell, MInard, & Engel, 2006).

The mirror through which most of the researchers used to study the adoption and development of new ideas as well as behavior prediction study is typically known as Innovation Diffusion Theory (Couros, 2003; Jamshidi & Hussin, 2013; Thambiah et al 2011b). In its basic form, Diffusion is defined as the process by which an innovation is adopted and gains acceptance by individuals or members of a community (Couros, 2003). According to Rogers (2003) Diffusion of Innovation Theory remained as the one of the most widely used models in innovation adoption studies. Over half a million studies were reported to have used the innovation diffusion theory (Rogers, 2003; Thambiah et al, 2011b; Jamshidi & Hussin, 2012). It has been consistently encouraging research in the area of adoption of an innovation Thambiah et al, (2010). Anuar, Adam, and Mohamad (2012) observed that innovation diffusion model was helpful in providing the researchers with a suitable platform for studying the adoption of product and services among varied individuals.

The sizeable number of studies of adoption has been more on the contexts other than Islamic banking, mostly on internet banking, technology, agriculture and health sectors (Al-Ghaith, Sanzogni, & Sandhu, 2010; Hoffmann, Franken, & Broekhuizen, 2012; Pannell, 2003; Rogers, 2003; Sadeghi & Farokhian, 2011). Very few but growing studies were concentrated to financial services and Islamic banking in particular (Amin, Abdul- Rahman, & Abdul-Razak, 2013; Echchabi & Aziz, 2012a; Jamshidi & Rezaei, 2012; Thambiah, Ismail, & Malarvizhi, 2011b). Gait & Worthington (2009) opined that in spite of the growing literature in the context of Islamic finance, much study using sophisticated modeling techniques are still needed especially on test Islamic banking implementation. It was further noted that notwithstanding the efforts made by the researchers in the context of Islamic banking however, the studies about customer’s implementation toward Islamic banking product and services are still insufficient (Hidayat & Al-Bawardi, 2012). And even the few studies were mostly conducted in Asia- Bangladesh, Malaysia, Pakistan, European Singapore; Middle East- Jordan, Libya, Morocco, Saudi- Arabia; and Europe and America- UK, USA. In Africa, particularly in Ethiopia such studies were scarce.

The current study has therefore adopted the research framework based on diffusion of innovation Model developed by Rogers 2003. The researcher modified this model by introducing two relevant factors: customer involvement and religious belief. Besides, that the study also examines the mediating of customer involvement and moderating s of religious beliefs on the relationship between –Awareness, relative advantage, compatibility, complexity and perceived risk and the Implementation of interest free banking services.

2.2 Empirical Literature Review

2.2.1 Origin, Evolution and Growth of Islamic Banking

The first attempt at Islamic banking system can be seen in Pakistan in the late 1950s with the establishment of Local Islamic Bank in the rural area. During that time, the owners of the land who were obedient to the Islamic teachings deposited their money to the bank, which was later loaned to other land owners for the purpose of agriculture development. The borrowers during that time were not charged for lateness in paying back their loans, other than a small amount for the purpose of bank operation. However, the operation of the bank was met with failure due to a number of factors such as the increase in the number of borrowers compared to the money being kept there, which resulted in vast difference between available capital and credit demanded, as well as the problem of the bank employees not having autonomous power on the bank operation. This was because the depositors of that time were hoping to get more benefits as a return for the money that they lent out (CIFP, 2006).

The second attempt was through setting of banking basic principle and Islamic finance that are to be practiced. The endeavor took place in Egypt from 1963 until 1967 through the establishment of Mit Ghamr Savings Bank in the town of Mit- Ghamr. The establishment of the bank was fully through the effort of Dr Ahmad al-Najjar and was done in a disclosed manner and did not use the Islamization platform as it might wrongly be interpreted as a manifestation of Islamic fundamentalism (Mustafa, 2005).This attempt was a result of a combination of the idea of German Savings Bank that was based on rural banking, with a general framework of Islamic values. The operation of the bank of that time was based on Islamic principles that are free from elements of interests, either to the depositors or from the borrowers (Joni and Hadenan,2006) The success of Mit Ghamr received praise and recognition from the Ford Foundation through its report in June 1967 because it had gained the support of the majority of the countryside residents, especially the farmers who regarded the bank as their own (El-Ashker, 1987).

In 1975, a number of Islamic banks that were trade oriented and aimed to offer an alternative in form of Islamic banking and replace the current conventional banking system were established in a few Islamic countries. There were two types of Islamic institutions as well as Islamic principle companies and investments. The first group of institutions was Dubai Islamic Bank, founded in 1975 (Mumin, 1999). From there in 1977 three Islamic banks were established as public limited companies, which were Kuwait Finance House in Kuwait, Faisal Islamic Bank in Egypt and Faisal Islamic Bank in Sudan by Pangeran Muhammad al-Saud. In the same year the International Islamic Bank Association was founded and based in Jeddah for the purpose of advancing the cooperation and coordination all the activities between the Islamic banks (Dakian, 2005).Since the establishment of Dubai Islamic Bank as the pioneer of Islamic trading bank, the world of Islamic banking and Islamic finance has grown rapidly and functioning successfully.

The evidence can be seen around 1980s and 1990s, when the establishment of new Islamic banks were a common phenomenon in the Islamic and non-Islamic countries. The most significant development for Islamic banking can be seen from the granting of license to a big firm which was Al-Rajhi Corporation that conducted foreign money exchange and trading with assets of more than USD 5 billion in Saudi Arabia (Mustafa, 2005).

In the 1977, a multinational investment company under the name Islamic Investment Corporation (ICC Limited) was established in Bahamas (CIFP, 2006). This company owned two branches in Sharjah, United Arab Emirate (UAE) and in Pakistan. In the following year, another public limited company was established in Jordan and became known as Jordan Islamic Bank for Finance and Investment (Cheah, 1994). The purpose of the establishment was to prepare funding and investment. Later in 1979, two more Islamic finance institutions that acted as public limited company came into reality, which were Bahrain Islamic Bank and United Arab Emirate Islamic Investing Corporation (Siddiqi, 1988). In the consecutive year, International Islamic Bank for investment and development of Egypt was established, followed by International Islamic Bank of Dakka and Masyraf Faysal al-Islami, Bahrain in 1982 (Traute, 1983).

Apart from Islamic countries, the growth of Islamic banks and banking institutions also took place in non-Islamic world, especially in the west and in the countries with Muslim minorities. An example can be seen when Philippines Trust Bank and International Islamic Bank of Denmark were established in 1973, followed in 1978 by the Islamic Banking International Holding in Luxemborg (Ausaf, 1995). The purpose of this bank was to create Islamic banks in different areas that have Muslims communities, as well as to involve in investment projects in both Islamic and non-Islamic countries. The operation of the investment company was further developed when another of its branch was opened in the city of London in June 1983 under the name Islamic Finance House, and another in Denmark, known as Islamic International Bank of Denmark. The growth became steady in 1990s; the market attracted the attention of public lawmakers and institution interested in introducing innovative products.

In 1991 Accounting and auditing organization for Islamic financial institutions (AAOIFI) established in Bahrain and responsible for developing and issuing standards for the Islamic finance industry. AAOIFI has 88 standards including: 48 Sharia; Accounting; Auditing; Governance; Ethics AAOIFI has over 200 members in more than 40 countries. Members include regulatory and supervisory authorities, international/intergovernmental organizations and market players, professional firms and industry associations.

The International Financial Services Board (IFSB) was launched in 2002 and serves as an international standard setting body that provides prudential standards and guidelines for regulatory and supervisory agencies to ensure soundness and stability of the Islamic Financial industry including: retail banking, capital markets and Takaful (Islamic insurance). The IFSB has13 standards, 5 guide notes, 1 technical note. As of September 2014, the IFSB comprises of 184 members from 41 jurisdictions, including 32 members from the African continent. IFSB has 55 regulatory and supervisory authorities, 8 international/intergovernmental organizations and 121 market players, professional firms and industry associations.

Today that Islamic banking industry showing an average growth rate of 17%-20% annually and comprises around 500 institutions in 80 countries, with an asset under management ranging between US $1.66-2.1 trillion, with expectations of market size to be $3.4 trillion by end of 2018 (Ernst & Young), according to Standard & Poor's Ratings Services the potential market is $4 trillion worldwide.

Figure-2.2.1-1: Historical Emergence of Interest-Free Banks

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Source : Sharia Fortune, December 2011

2.2.2 Underlying Principles of Interest-free Banking

Banking The IFB is governed by the following pillars that basically align to the Sharia Law as articulated by different authors;

2.2.2.1 The IFB Business is based on Islamic (Sharia) Law

According to Abdul-Rahman (2010), Shanmugam and Zahari, (2009,) and Hassan and Lewis (2007) the main characteristic of these financial instruments is that they are compliant with the shari‟a – the Islamic legal system. The Sharia Law compliance aspect of the IFB is monitored by team of independent Sharia Scholars called Sharia Committee. These laws as referred to the convention are consolidated in (Shari’a Standards for Islamic Financial Institutions, 1432 H-2010). The principles and sources of Shari’a are: the Qur’an, which is the unchangeable and the proven inculcation of all God’s messages to all His prophets, including the Torah and the Gospel; and the way of life and example of living (Sunnah) and sayings (Hadeeth) of Prophet Muhamma. Moreover, they articulate the necessity of independent Sharia Board in that is entrusted give reasonable assurance of the Sharia Compliance aspect of the IFB.

2.2.2.2 Paying or Receiving Interest (Riba) Is Forbidden (Haram)

As Islamic banking is interchangeably call interest-free banking paying or receiving interest (riba) is forbidden and this is considered as one of the governing principles of the banking convention. As articulated by Lina (2004) and Shanmugam and Zahari (2009,), lending money at interest has been condemned by men like Plato, Aristotle, Plutarch, Seneca and Cicero, early fathers of the Christian church; the majority of popes and councils up to 1830; likewise modern authors such as Goethe and Wagner. The author then underscores the fight against usury (interest) goes back to the earliest beginnings of civilization. (Ethica‟s Handbook of Islamic Finance, 2013 ed.,) stated that the concept of riba was widely recognized among the addressees of the Holy Quran, and it is that concept which is reflected in the legal definition provided for riba either in the hadith or in the later literature of Islamic jurisprudence. According to this definition, any transaction of loan where the payment of an additional amount on the principal is made conditional to the advance of such a loan is called riba and hence forbidden in Islamic banking. As the convention basis on Sharia Principle that bases on Holy Quran, riba is considered as one of the prohibitions in IFB.

2.2.2.3 Utmost Fairness in All Business Dealings

Fairness I all business dealings is a peculiar feature of the convention irrespective of religion background. According to Meezan bank (2014), if we consider the injunctions of the Holy Quran, it would appear that the system for the distribution of wealth laid down by Islam envisages three objects:

- The establishment of a practicable system of economy,
- Enabling everyone to get what is rightfully due to him, and
- Eradicating the concentration of wealth. It further synthesizes that, of these three objects of the distribution of wealth, the first distinguishes Islam economy from Socialism, the third from Capitalism, and the second from both the same time.

2.2.2.4 Transparency, Consensus and Contractual Agreement between Parties in All Business Dealings

In all business dealings transparency, consensus is a precondition so as all parties make informed decision that will subsequently is substantiated by contractual agreement. Contractual agreements set out the terms and conditions upon and subject to which the person has agreed to purchase the Goods/Service from time to time from the Suppliers and upon which the Institution has agreed to sell the same to the client from time to time by way of facility Shanmugam and Zahari (2009) and Ethica‟s Handbook of Islamic Finance (2013 ed.).

2.2.2.5 Profit-and-loss Sharing

The return allocation from IFB is governed by the concept of sharing profit as agreed but loss as per the capital contributed for both the fund mobilization and the financing dimensions. According to Hassan and Lewis (2007), the main difference between an Islamic or interest-free banking system and the conventional interest-based banking system is that, under the latter, the interest rate is either fixed in advance or is a simple linear function of some other benchmark rate, whereas, in the former, the profits and losses on a physical investment are shared between the creditor and the borrower according to a formula that reflects their respective levels of participation. In Islamic finance, interest-bearing contracts are replaced by a return-bearing contract, which often takes the form of partnerships.

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