Islamic Banking in Somalia; Challenges and Opportunities

Islamic Banking in Somalia; Challenges and
Opportunities
DAUD DAHIR HASSAN (MATRIC NO: LC00052000040)
THESIS SUBMITTED IN FULFILMENT FOR
MASTER DEGREE OF BUSINESS
ADMINISTRATION IN ISLAMIC BANKING AND
FINANCE
FACULTY OF BUSINESS ADMINISTRATION
LINCOLN UNIVERSITY COLLEGE
2018

I
DEDICATION
I dedicate this thesis to my lovely parent my mother Fatima Yusuf Mohamed and My
father Dahir Hassan Musse and my dear Raqiyo Shire Ibrahim for their endless love,
support and encouragement.

II
DECLARATION
I hereby declare that this thesis is my own work and effort and that it has not been submitted
anywhere for any award. Where other sources of information have been used, they have
been acknowledged.
Signature: ……………………………………….
Date: …………………………………………….

III
CERTIFICATE OF APPROVAL
We hereby declare that this thesis is from the student’s own work and effort, and all other
sources of information used have been acknowledged. This thesis has been submitted with
my approval
SUPERVISOR:
SIGNATURE………………
DATE: …………………….

IV
ACKNOWLEDGEMENT
First and foremost, praise is to Allah the Almighty, on whom ultimately we depend for
sustenance and guidance. Foremost, I would like to express my sincere gratitude to my
advisor Prof. Mohamed Said for his continuous support of my thesis study and research,
for his patience, motivation, enthusiasm, and immense knowledge. His guidance helped
me in all the time of research and writing of this thesis. I could not have imagined having
a better advisor and mentor for my study. Besides my advisor, I would like to thank and
recognize the contributions of Mr Awil Nour: PhD candidate at Anadolu University, Dr
Mohamed Hassan: Associate Professor at Mogadishu University and Mr. Abdifitah Bayle
Lecturer at East Africa University.
Special Thanks due to my dear brothers and sisters with their continuous support and daily
encouragement as I would like to thank whole and rest of my family. I would like to say
thank you. Last but not the least, I would like to thank my dear friend Abdikarem Ibrahim
and all my friends for their contribution due to the completion of my thesis.
Extraordinary gratitude to Lincoln University College Administrators, lecturers and
classmates, I would like to express my deepest appreciation to the great authors whom I
quoted their articles, thank you. Lastly I would like to thank the participants in my survey,
who have willingly shared their precious time during the process of Questionnaire.

V
Abstract
Nowadays, we hear about the emerging of Islamic banking in Somalia. The most
important purpose of this study was to gain the challenges and opportunity that are facing
Islamic banking in Somalia.
The methods and procedures used in gathering data was primary and secondary data.
Document review questions and personal interviews were used to gather data for the study.
Research papers on Islamic banking, textbooks, magazines, and websites were used to
analyze information for the purpose.
Questionnaire were prepared with the help of some banking experts and structured in a way
that would enable everyone to answer and contribute something. The questionnaire was
originally developed in English and was translated to Somali language so that Somali
speaking participants could understand very well.
To be specific, research finding shows that The absence of Shariah advisory board in the
country, lack of active central Bank and Lack of Financial institution, Lack of awareness
and proper understanding is one of the challenges that facing Islamic Banking in Somalia.
On the other hand, the research findings show that there are greater opportunities in the
Somalia for Islamic banks because the social acceptance for Islamic banking and finance
in the country is higher compared to conventional banks, and the existing of some informal
practice of Islamic banking products facilitates to have a formal Islamic banking system.

VI
Abbreviation latter
FI: Financial Institution
CBS: Central Bank of Somalia
BisB: Bahrain Islamic Bank
IFSB: Islamic Financial Services Board
AAOIFI: Accounting and Auditing Organization for Islamic Financial Institutions
IDB: Islamic Development Bank
IIFM: International Islamic Financial Market
IILM: Islamic Liquidity Management Corporation
IMF: International Monetary Fund
LC: Letter of Credit
SSB: Salam Somali Bank

VII
List of Tables
Table 1: Gender of the respondent
Table 2: Marital Status of the Respond
Table 3: Level of Education of the respondent
Table 4: Age of Responder
Table 5: Location of respondent
Table 6: Have you heard about Islamic Banking
Table 7: Somalia is ready for implementing Islamic banking system
Table 8: Is there a clear Islamic financial institution in Somalia
Table 9: Is there any financial Institution in Somalia that provides financial
Table 10: Have you ever been a customer of an Islamic Bank in Somalia
Table 11: reasons which motivate people to deposit in Islamic bank
Table 12: Do you thing Islamic financial services are relevant
Table13: Islamic Banks in Somalia are providing enough retail products
Table 14: Islamic Banks in Somalia are contributing in removing society’s inequalities
Table 15: Islamic banks and financial institutions in Somalia are free from exploitation
Table 16: Products of present Islamic Banking activities in Somalia are less practiced
comparing to other countries in Middle East

VIII
Table 17: Current global trends in Financial Services will have positive manifestations on the future
of Islamic banking in Somalia
Table 18: Risk associated with Islamic bank and Finance can be minimized
Table 19: Social acceptance for Islamic banking and finance in the country is higher compared to
conventional banks
Table 20: Islamic banks will capitalize the Availability of profitable projects in the area of
infrastructure, agriculture and trade financing in Somalia
Table 21: evaluate the efficiency and performance of Islamic Banks in Somalia especially
the last decade
Table 22: Local Community has awareness about Islamic banking system
Table 23: There is inadequate education and knowledge about Islamic banking and finance in
Somalia
Table 24: Awareness about Islamic financial system is low and it is difficult adopt it recently
Table 25: Absence of Sharia advisory board in the country is one of the obstacles that bankers must
face
Table 26: Lack of Islamic Financial regulation is One of the challenges that facing Islamic Banking
in Somalia
Table 27: Lack of active and functional Central bank have an effect on Islamic Banks in Somalia
Table 28: Islamic Banks in Somalia provide variety of mode of service; (E-banking and Mobile
Banking)
Table 29: Service offered by Islamic Banks in Somalia are efficient and time effective

IX
Table 30: Islamic Banks in Somalia are so-called Islamic Banks and do not offer wide variety of
products and services?
Table 31: There are many procedures/regulations that are needed to be followed in Islamic Banks
in Somalia

X
List of Figures
Figure 1: Gender of the respondent
Figure 2: Marital Status of the Respond
Figure 3: Level of Education of the respondent
Figure 4: Age of Responder
Figure 5: Location of respondent
Figure 6: Have you heard about Islamic Banking
Figure 7: Somalia is ready for implementing Islamic banking system
Figure 8: Is there a clear Islamic financial institution in Somalia
Figure 9: Is there any financial Institution in Somalia that provides financial
Figure 10: Have you ever been a customer of an Islamic Bank in Somalia
Figure 11: reasons which motivate people to deposit in Islamic bank
Figure 12: Do you thing Islamic financial services are relevant
Figure13: Islamic Banks in Somalia are providing enough retail products
Figure 14: Islamic Banks in Somalia are contributing in removing society’s inequalities
Figure 15: Islamic banks and financial institutions in Somalia are free from exploitation
Figure 16: Products of present Islamic Banking activities in Somalia are less practiced
comparing to other countries in Middle East

XI
Figure 17: Current global trends in Financial Services will have positive manifestations on the
future of Islamic banking in Somalia
Figure 18: Risk associated with Islamic bank and Finance can be minimized
Figure 19: Social acceptance for Islamic banking and finance in the country is higher compared to
conventional banks
Figure 20: Islamic banks will capitalize the Availability of profiFigure projects in the area of
infrastructure, agriculture and trade financing in Somalia
Figure 21: evaluate the efficiency and performance of Islamic Banks in Somalia especially
the last decade
Figure 22: Local Community has awareness about Islamic banking system
Figure 23: There is inadequate education and knowledge about Islamic banking and finance in
Somalia
Figure 24: Awareness about Islamic financial system is low and it is difficult adopt it recently
Figure 25: Absence of Sharia advisory board in the country is one of the obstacles that bankers
must face
Figure 26: Lack of Islamic Financial regulation is One of the challenges that facing Islamic Banking
in Somalia
Figure 27: Lack of active and functional Central bank have an effect on Islamic Banks in Somalia
Figure 28: Islamic Banks in Somalia provide variety of mode of service; (E-banking and Mobile
Banking)
Figure 29: Service offered by Islamic Banks in Somalia are efficient and time effective

XII
Figure 30: Islamic Banks in Somalia are so-called Islamic Banks and do not offer wide variety of
products and services?
Figure 31: There are many procedures/regulations that are needed to be followed in Islamic Banks
in Somalia.

XIII
Table of Contents
Dedication……………………………………………………………………………….I
Declaration……………………………………………………………………………….II
Certificate of Approval…………………………………………………………………III
Acknowledgement………………………………………………………………………IV
Abstract…………………………………………………………………………………...V
Abbreviation letters………………………………………………………………………VI
List of Tables…………………………………………………………………………....VII
List of figures……………………………………………………………………………..X
Table of Contents……………………………………………………………………....XIII
1 CHAPTER ONE: INTRODUCTION ...........................................................................
1.1 Background of Study............................................................................................ 1
1.2 Statement of the problem ..................................................................................... 4
1.3 Purpose of the Study ............................................................................................ 5
1.4 Objectives of the Study ........................................................................................ 6
1.5 Research Questions .............................................................................................. 6
1.6 Scope of the Study................................................................................................ 6
1.6.1 Geographical scope....................................................................................... 6
1.6.2 Theoretical scope .......................................................................................... 7
1.6.3 Time scope.................................................................................................... 7
1.7 Definition of Terms.............................................................................................. 7
1.8 Limitation of the Study ........................................................................................ 8
1.9 Conceptual Framework ........................................................................................ 8

XIV
1.10 Significance of the Study ..................................................................................... 9
2 CHAPTER TWO: LITERATURE REVIEW............................................................ 10
2.1 Introduction........................................................................................................ 10
1.1 Islamic Economic Model ................................................................................... 10
1.1.1 The view point of Islamic Banking............................................................. 12
1.1.2 Evolution of Islamic Banking..................................................................... 13
1.1.3 Instruments and Financial products of Islamic Banks................................ 17
1.1.4 Retail Islamic Banking Products................................................................. 28
1.1.5 Islamic Laws on Trading ............................................................................ 30
1.1.6 What is Islamic Forex Trading?................................................................ 31
1.1.7 Risk Management in Islamic Banks ........................................................... 32
1.2 Financial institutions in Somalia........................................................................ 35
1.2.1 RIEF HISTORY OF THE SOMALI FINANCIAL INSTITUTIONS ....... 36
1.2.2 Current profile of Financial Sector in Somalia........................................... 41
1.3 Islamic Banks in Somalia................................................................................... 43
1.3.1 Commercial Versus Islamic Banking in Somalia ....................................... 44
1.3.2 Islamic Finance education in Somalia ........................................................ 45
1.3.3 Opportunities of Islamic Banking in Somalia............................................. 46
1.3.4 Products of Islamic Banks in Somalia ........................................................ 47
1.3.5 Growth of Islamic Finance in Somalia ....................................................... 48
1.4 Challenges Facing Islamic Banking Services .................................................... 48
1.4.1 Lack of Awareness and understanding ....................................................... 48
1.4.2 Regulatory Challenges................................................................................ 48
1.4.3 Lack of Supportive Institutional and Market links ..................................... 49
1.4.4 Use of Advanced Technology and Media................................................... 49

XV
1.4.5 Need for Professional Bankers.................................................................... 50
3 Chapter three: methodology ...................................................................................... 51
3.1 Introduction........................................................................................................ 51
3.2 Research design.................................................................................................. 51
3.3 Population and sampling.................................................................................... 51
3.3.1 Study population......................................................................................... 51
3.3.2 Sample of the study..................................................................................... 52
3.4 Sampling procedure............................................................................................ 52
3.5 Data Collection................................................................................................... 53
3.5.1 Instrumentations.......................................................................................... 53
3.6 Quality control of the study................................................................................ 53
3.6.1 Validity ....................................................................................................... 53
3.6.2 Reliability.................................................................................................... 53
3.7 Data Analysis ..................................................................................................... 54
3.8 Ethical Considerations........................................................................................ 55
3.8.1 Permission to conduct the research............................................................. 55
3.8.2 Informed Consent........................................................................................ 55
3.8.3 Confidentiality and secrecy......................................................................... 55
4 CHAPTER FOUR PRESENTATION, ANALYSIS AND INTERPRETATION OF
DATA ............................................................................................................................... 56
4.1 Overview............................................................................................................ 56
4.2 Characteristics of respondent ............................................................................. 56
4.2.1 Gender of Respondents............................................................................... 57
4.2.2 Marital status............................................................................................... 58
4.2.3 Educational Level ....................................................................................... 59

XVI
4.2.4 Age of Respondents .................................................................................... 60
4.3 General Awareness about Islamic Banking in Somalia ..................................... 61
4.3.1 Have you heard of Islamic Banking and finance? ...................................... 61
4.3.2 Is Somalia ready for implementing Islamic banking system...................... 62
4.3.3 Is there an Islamic financial institution governed by Islamic Banking?..... 64
4.3.4 Islamic Financial institutions provide Financial Service............................ 65
4.3.5 Being a customer of Islamic Bank.............................................................. 66
4.3.6 Reason motivate people to deposit money in Islamic Bank ....................... 67
4.3.7 Role of Islamic Banks on Economic Growth ............................................. 68
4.3.8 Products of Islamic banks........................................................................... 69
4.3.9 Islamic banks contribute removing social inequalities............................... 70
4.3.10 Islamic banks are free from exploitation, discontentment and strife.......... 71
4.3.11 Products of local banks compared to banks in middle east ........................ 73
4.4 Opportunities of Islamic banks in Somalia. ....................................................... 74
4.4.1 Relation between global Financial trends in and future of Islamic Finance74
4.4.2 Risk Associated with Islamic Banks in Somalia......................................... 75
4.4.3 Social acceptance of Islamic Banking in Somalia ...................................... 76
4.4.4 Islamic bank and available profitable projects............................................ 77
4.4.5 Evaluation for performance of Islamic banks in Somalia based on perception
79
4.5 Challenges of Islamic Banking in Somalia ........................................................ 80
4.5.1 Awareness of Local Community ................................................................ 80
4.5.2 Inadequate education about Islamic Finance.............................................. 81
4.5.3 Awareness of Islamic Finance in Somalia.................................................. 82
4.5.4 Absence of Sharia Board of Advisors......................................................... 83

XVII
4.5.5 Lack of Islamic Financial regulation in Somalia........................................ 84
4.5.6 Absence of effective central bank have an effect on Islamic banks in Somalia
86
4.5.7 Islamic Banks in Somalia provide variety of mode of service ................... 87
4.5.8 Efficiency and effectiveness of service offered by Islamic Banks in Somalia
88
4.5.9 Banks in Somalia are so-called Islamic Banks ........................................... 89
4.5.10 Procedures that Islamic banks are needed to follow................................... 90
5 CHAPTER FIVE: FINDINGS, CONCLUSIONS AND RECOMMENDATIONS. 92
5.1 Overview............................................................................................................ 92
5.2 Findings.............................................................................................................. 92
5.2.1 Opportunities of Islamic banking in Somalia ............................................. 93
5.2.2 Challenges of Islamic Banking in Somalia................................................. 94
5.3 Conclusion.......................................................................................................... 95
5.4 Recommendations.............................................................................................. 96
References……………………………………………………………………………………………………………………………….98
Appendix (1): Questionnaire……………………………………………………………………………………………………101
Appendix (2): Glossary of Islamic Banking………………………………………………………………………………107

1
1 CHAPTER ONE: INTRODUCTION
1.1 Background of Study
Islamic Banking refers to a system through which finance is provided in the form of money
in return for either equity or rights to share in future business profits, or in the form of
goods and services delivered in return for a commitment to repay their value at a future
date.1
The Islamic finance industry has expanded rapidly over the past decade, growing at 10-
12% annually. Today, Sharia-compliant financial assets are estimated at roughly US$2
trillion, covering bank and non-bank financial institutions, capital markets, money markets
and insurance (“Takaful”). Over the past decade Islamic finance has emerged as an
effective tool for financing development worldwide, including in non-Muslim countries.
Major financial markets are discovering solid evidence that Islamic finance has already
been mainstreamed within the global financial system – and that it has the potential to help
address the challenges of ending extreme poverty and boosting shared prosperity
(Alawode, 2015).
In 1979, the first Islamic and Commercial Bank, Faisal Islamic Bank started in Egypt. It
provides funding to support financial activities through Zakat fund. It was followed by the
establishment of Bahrain Islamic Bank (BisB) in the same year, the first Islamic
commercial bank in Kingdom of Bahrain. The milestone of Islamic banking and financial
1
This definition is derived from the keynote address delivered by Dr. Mabid Ali Al-Jarhi, the then Director of the Islamic
Research and Training Institute, at the Conference on Islamic banking and finance held at Brunei, Darussalam, Brunei
and jointly organized by IRTI and the University of Brunei during 5-7 January 2004.

2
institution in Malaysia started in 1983, when Bank Islam Malaysia Berhad was founded.
The establishment of Bank Islam in Malaysia is a significant of development of Islamic
banking in Malaysia. In 1991, Bahrain realized that there is a need to set up an accounting
and auditing standard to standardize and regulate the operation for Islamic Financial
Institution. Hence, the accounting and auditing standard was established. Malaysia formed
an Islamic Financial Services Board (IFSB) in 2002 to regulate the Islamic financial
services industry by established a supervisory standard and principles that compliance with
Shariah. The industry has set up international regulatory institutions to guide operations
around the world, although it has been difficult to ensure standardization of Islamic
products across different countries. The Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI), based in Bahrain, issues international standards on
accounting, auditing, and corporate governance, while the Islamic Financial Services
Board (IFSB), based in Malaysia, is in charge of standards for supervision and regulation.
Some factors appear to be correlated with the diffusion of Islamic banking, 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 (Imam
and Kpodar, 2010; Ilias, 2010; Alam, 2012). A key driver behind interest in Islamic finance
today is the possibility of tapping the international sukuk market, which does not require a
domestic Islamic financial system (e.g., Japan has issued sukuk, as well as many others
countries). At the same time, the development of Islamic banking in some countries might
facilitate risk sharing and improve financial inclusion.

3
In light of Africa’s bright economic prospects and rapidly growing population, where
currently more than 1 billion people call it home, the continent boasts relatively untapped
potential for Islamic finance. While still comparatively underdeveloped, Islamic finance
has recently made significant strides into the continent. Several countries in Africa are
already planning sukuk debuts for this year, including Tunisia, Egypt, and Kenya. This
follows first-time sovereign sukuk issues by South Africa and Senegal in 2014 and Nigeria
in 2013, highlighting the key role of governments in spearheading the development of the
industry. On the consumer front, Islamic finance can be utilized as a strategic tool to tap
into the unbanked population in Africa, while addressing the issue of financial inclusion in
several ways. For example, risk-sharing contracts inherent in Islamic finance
complemented with the redistribute instruments such as zakat, sadaqah, qard al-hassan and
waqf can create an enabling environment for economic and social development, which
bodes well for overall growth (Al-Aboodi, 2015).
However, the Somalia’s financial system has been decimated by the last two decades of
conflict. In January 1991, all state institutions that provided services and regulated the
economy collapsed, including the Central Bank of Somalia and the entire banking system.
Somalia has developed Financial Institution Law No. 130/2012, which provides the general
guidelines of financial institutions operations, both Islamic and conventional. This situation
leaves the financial industry to accommodate and to be open for conventional financial
institutions.
After the collapse the Somalia Economy was deeply depending on Money Transfer
Companies (Hawala System) which have arisen with the hope to fulfil this gap and deliver
some of basic banking services. As a result, Hawala System becomes the major financial

4
institutions in the country due to their faster and cheap service charges, growing public
trust and the reliability on its service and due to having agencies across the world, which
are handling up to $1.6 billion in remittance annually to the home land (CIA world fact-
book statistics, 2012). The role of the Hawala system is not ended with transferring money
from overseas to back home, but it plays important role in trade and local investment
financing since there is no investment and commercial banks in Somalia. Moreover, the
Hawala system acts as a saving bank by accepting the public deposits in its current and
saving accounts.
1.2 Statement of the problem
After the collapse of the central government of Somalia in 1991, the country hasn’t had a
formally effective banking system that provides basic banking services except Hawala
business for money transfer services and small unstructured deposits. Though effective
Banking policies and regulations are not still yet in place, but, in recent years a number of
private commercial banks operating under the Islamic banking principles have emerged.
However, there are several unique challenges facing Somalia’s banking industry, such as
lack of technical experts, lack of comprehensive and appropriate financial instruments and
supportive infrastructures, limited public financial knowledge capacity, limited funding
capacity and so many others.
(Yussuf, 2014) researcher “Islamic Banking in Somalia; challenges and opportunities and
found that “The prime challenges facing Islamic banking in Somalia is Lack of qualified
Islamic banking personnel, so this study recommended Further training and Islamic finance
education should be given to bank personnel to up skill them to offer quality service and
appropriate advice to bank customers”. Yussuf concentrated on the absence of qualified

5
Islamic banking personnel and lack of sharia advisory board, However, unlike that my
study will cover up the following aspects that previous research doesn’t attempt to covers;
Financial regulations, customer awareness and financial products offered by Islamic banks
in Somalia.
However, in this study, the researcher will examine the major challenges experienced by
Islamic financial institutions in Somalia, more specifically the following challenges;
The effect of the absence of effective and comprehensive Financial regulation that controls
the operations of Islamic Banks in Somalia.
Although a number of Islamic banks are currently operating in Somalia, but the majority
of public don’t have bank accounts and they don’t involve banking transactions, therefore,
this paper will examine public perception and attitude towards Islamic Banking.
Currently, the existing banks offer limited products and service to their clients, therefore,
the researcher will investigate why banks failed to offer complete and diverse products and
service tailored to the different client’s needs.
1.3 Purpose of the Study
The purpose of this study is to investigate the Challenges and opportunities of Islamic
banks in Somalia, using historical resulting knowing of Islamic banks in Somalia, in this
study the agents of Challenges and opportunities of Islamic banks in Somalia will be
defined the Customer’s Perception, Awareness, Regulation and Limited product of Banks
as independent variables of the study while the Challenges and Opportunities of Islamic
Banks in Somalia are the dependent variable of the study.

6
1.4 Objectives of the Study
The general objectives of the study were to examine the challenges and opportunities of
Islamic banks in Somalia, the study was tested to realize the following specific objectives:
1. To establish the effect of Customer perception on Islamic Banks in Somalia.
2. To figure out the regulatory situation of Islamic financial institutions in Somalia.
3. To investigate the product of Islamic Financial institutions in Somalia.
1.5 Research Questions
In order to achieve the objectives of the study and to properly address the research problem,
some research questions were designed accordingly.
1. How does customer perception effect the Islamic Banks in Somalia?
2. How is the regulatory situation of Islamic Bank institutions in Somalia?
3. Does Islamic Banks offer a variety and sharia matched Islamic Products?
1.6 Scope of the Study
1.6.1 Geographical scope
This study was conducted to investigate the challenges and opportunities of Islamic Banks
in Somalia consists all its territory, mainly eight major cities which are Mogadishu,
Hargaisa, Bosaso, Kismayo, Galkaio, Baidoa, Baletwaine and Garoe.

7
1.6.2 Theoretical scope
This study was focusing on Islamic Banks in Somalia; Challenges and Opportunities, in
terms of Customer perception, situation of Financial regulatory and product of Islamic
Banks in Somalia.
1.6.3 Time scope
The study on Islamic Banking in Somalia; challenges and opportunities was conducted for
the last year.
1.7 Definition of Terms
Central Bank of Somalia: is the monetary authority of Somalia. Among other duties, it is
in charge of ensuring financial stability, maintaining the internal and external value of the
local currency, and promoting credit and exchange conditions that facilitate the balanced
growth of the national economy (Central Bank of Somalia, 2018). Within the scope of its
powers, it also contributes to the financial and economic policies of the State. The Central
Bank of Somalia was founded in April 8, 1950. After the state collapse in 1991 the Central
Bank of Somalia was re-opened in 2009 by Transitional Federal Government as part of its
campaign to restore national institutions (AFDB, 2009).
Sukuk: it is defined as certificates of equal value representing undivided shares in the
ownership of tangible assets, usufructs2 and services or (in the ownership of) the assets of
particular projects or special investment activities. In addition to that Sukuk can be
2
Use of benefit of an asset

8
considered as undivided shares in the ownership of underlying assets (tangible or
intangible) relating to a particular project or investment activity by AAOIFI.
1.8 Limitation of the Study
The potential limitation in conducting this study includes but not limited to; lack of relevant
and exhausted related research works on the subject. The other important limiting factor
that is worth of mentioning lies with the participants of the study. Most of the participants
don’t have clear understanding about the intents of the study and there is inherent risk of
extreme reservations in full participation, if any, due to the high sensitivity and versatility
when it comes to religious matters, especially this time around.
Possible limitations in conducting this study include but not limited to; respondents were
suspicious of possible investigations by competing firms similarly there is possibility of
dealing with respondents who could not respond in English.
1.9 Conceptual Framework
In the study, the theoretical framework is needed in order to know the relationship from
one variable to the other variables. A variable is anything that can take on differing or
varying value. In the theoretical framework there are two variables are used to identify
for each other which is:
 Dependent variable (criterion variable) - is the primary interest to the researcher.
 Independent variable (predictor variable) - is one that influence the dependent variable
in either a positive or negative way
The schematic diagram for the theoretical is as follow:

9
Independent Variables Dependent Variables
1.10 Significance of the Study
The findings of the study will be useful in many ways and too many parties. This study of
Islamic Banks in Somalia; Challenges and Opportunities is expected to give an investment
tip to both current as well as potential investors to target this untapped market which will
help in improving the economy, living standard of citizens as well as competition and
efficiency.
This study is to show some important points about the challenges and opportunities of
Islamic Banks in Somalia and became useful material to reference by other researchers to
undertake a further detailed investigation on the subject and providing relevant empirical
evidences. This study will help the people to become aware of Islamic banking in Somalia
and also lead more Masters students to continue research from where I left over or eliminate
the mistakes I did or part I left.
The results of the study will help the disenfranchised Muslim community in general and
the business community in particular. It will also benefit those concerned policy makers to
formulate necessary and solution-oriented policies that will in fact have a benefit to all
citizens.
Awareness of the
customer
Perception
Regulatory situation
Challenges &
Opportunities of
Islamic Banking

10
2 CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction
In this chapter, the related literature will be reviewed and discussed. The literature
concerning the prospects and challenges of Islamic Banking in Somalia and elsewhere will
be presented. The relevant literature will be collected from different secondary sources and
it includes material about the Islamic economic model, evolution of Islamic banking, key
financial instruments, and Islamic banking literature versus practice, empirical evidences
on Islamic banking, challenges as well as the need for Islamic banking in Ethiopia will be
analyzed in the following sections of this chapter.
1.1 Islamic Economic Model
The Islamic Economic Model aims to guarantee individual liberty, freedom of choice,
private property and enterprise, the profit motive and possibilities of unlimited effort and
reward. On the other hand, it seeks to provide effective moral filters at different levels of
life and activity and established institutions in the voluntary sector, as well as through state
apparatus to ensure economic development and social justice in the society.
Some of Islamic Financial experts argue that early Islamic theory and practice formed a
"coherent" economic system with "a blueprint for a new order in society, in which all
participants would be treated more fairly". Michael Bonner, for example, has written that
an "economy of poverty" prevailed in Islam until the 13th and 14th centuries. Under this
system God's guidance made sure the flow of money and goods was "purified" by being
channeled from those who had much of it to those who had little by encouraging zakat

11
(charity) and discouraging riba (interest) on loans. Islam does not prescribe a particular
economic system but provides the core elements and principles, which form the basic
philosophy of a system or an economy. Islam provides primarily normative principles for
economics and finance. However, it is not devoid of positive economic statements or
hypotheses. Several areas of economics are truly positive and cannot be different in an
Islamic or in any other framework. The Islamic economic model has been developed over
time based on the rulings of Sharia on commercial and financial transactions. The Islamic
financial framework, as seen today, stems from the principles developed within this model,
some of which are outlined below (Saidat.A.Otiti, 2018):
 Any predetermined payment over the actual amount of principal is prohibited
Only good loans are allowed in Islam whereby the lender does not charge any
interest or additional amount over the money lent.
 A lender must share in the profits or losses arising out of the venture for which
the money was lent Islamic finance is based on the belief that the provider of
capital and the borrower should collaborate to a certain extent in business ventures.
However, as the hoarding of wealth is discouraged, agents must choose whether to
invest their money with some risk or let their money devaluate under inflation.
 Money cannot be made from just having money is only a medium of exchange,
a way of defining value. It has no value in itself and therefore should not be allowed
to create more money. Money is viewed as potential capital as opposed to capital.
 Uncertainty and risk is prohibited Ideally, under this rule, any transaction entered
into should be free of uncertainty, risk and speculation. No information

12
asymmetries should exist between lender and borrower. With this, parties cannot
predetermine a guaranteed profit.
1.1.1 The view point of Islamic Banking
Islamic Banking is a System that only offers products that conform to the sharia, or
Islamic law. For example, in Islamicbanking, checking and savings deposits do not accru
e interest. They either lie dormant until withdrawal or areinvested. Because this involves
higher risk than conventional banking services, various highly technical productshave bee
n developed to mitigate risk and generally imitate "regular" banks as much as possible wh
ile still complyingwith Islamic law. Considerable debate exists as to whether these Islami
c banking products are in fact sharia-compliant (Farlex Financial Dictionary, 2018).
The establishment of the Islamic Development Bank (IsDB) in 1975 was a watershed
moment for Islamic banking, coming just after the establishment of the first major Islamic
commercial bank—the Dubai Islamic Bank—in the United Arab Emirates. The success of
the latter led to the establishment of a series of similar banks, including Faisal Islamic Bank
(Sudan) and Kuwait Finance House (Kuwait)—both in 1977. As early as the late 1970s,
steps were taken in Pakistan for making the financial system compliant with Sharia
principles. The legal framework was then amended in 1980 to allow for the operation of
Sharia compliant profit-sharing financing companies, and to initiate bank finance through
Islamic instruments. Similarly, Iran enacted a new banking law in August 1983 to replace
conventional banking with interest-free banking. The law gave banks a window of three
years for their operations to become compliant with Islamic principles. Sudan’s efforts to
align its entire banking system with Sharia principles began in 1984. The financial
infrastructure, including standards setting and regulatory institutions, has also been

13
catching up with the rapid growth of Islamic financing. International standard-setting
institutions were established to guide the operations of the industry around the world,
although standardization of Islamic products across different countries remains a
challenge. Since 1991, the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI), based in Bahrain, has been issuing accounting, auditing, and Sharia
standards for financial reporting at Islamic financial institutions. The Islamic Financial
Services Board (IFSB), established in 2002 in Malaysia, is responsible for issuing
supervisory and regulatory standards and guidelines.3 It also promotes the adoption of
these standards and guidelines by relevant regulatory authorities. In 2001, the International
Islamic Financial Market (IIFM) in Bahrain was mandated to develop guidelines for the
issuance of Islamic financial instruments and to encourage active secondary market
trading. Most recently in 2010, the Malaysia-based International Islamic Liquidity
Management Corporation (IILM) started issuing short-term Sharia-compliant financial
instruments to facilitate cross-border Islamic liquidity management (Mumtaz Hussain,
Asghar Shahmoradi, and Rima Turk , 2015).
1.1.2 Evolution of Islamic Banking
Since the mid-70s Islamic banking and finance has expanded to about 70 countries
encompassing most of the Muslim world; about 55 developing and emerging market
countries and 13 other locations around the world, including Australia, Bahamas, Canada,
Cayman Islands, UK and Switzerland.
Early experiments with Islamic Banking took place in Malaysia in the mid-1940s, in
Pakistan in the late 1950s and Egypt’s Mit Ghamr Savings Bank (1963) and Nasser Social
Bank (1971). In the Arab world the 1st modern experiment with Islamic banking was

14
undertaken in Mit Ghamr, Egypt in 1963. The experiment combined the idea of German
Savings banks with the principle of rural cooperative banking within the general
framework of Islamic financing, to cater for those unwilling, for religious reasons, to deal
with the conventional banks. It however operated invariably undercover for fear of being
labelled as ‘Islamic Fundamentalism’ which would have been anathema to the political
reign. Infact, in 1976, Mit Ghamr Savings bank was closed and its operation taken over by
the Natioanl Bank of Egypt and made interest based. Nine other such banks were taken
over within the same period in Egypt.
Similar political antagonism to Islamic financial institutions, occurred elsewhere in the
Muslim world; Iraq, Oman, Syria and even Saudi Arabia. Two institutions that however
survived this early period were the Nasser Social Bank established in 1971 in Egypt and
Tabung Hajj, established in 1963 in Malaysia. Nasser Social Bank operated as a public
authority with autonomous status but without specific reference to Islam in its Charter
while Tabung Hajj was set up in 1963 initially as The Muslim Pilgrims Savings
Corporation to help would-be pilgrims save towards Hajj - it gradually evolved into a non-
bank financial institution, the success of which provided the needed impetus for
establishing a full-fledged Islamic bank in Malaysia: - Bank Islam Berhad (BIMB) was
thus established in 1983. From the mid-70s a new era was witnessed in the history of
Islamic Banking in the wake of oil wealth. Energy price rises provided the financial capital
to support an expansion of both conventional and Islamic Banks and oil resources enabled
a wide range of institutions to participate in the social and economic development of
Muslim countries, the result was a change in the political climate in many Muslim countries
hence largely dispensing the need to operate Islamic financial institutions under cover.

15
A visible achievement arising from oil-related resource boosting is the establishment of the
Islamic Development Bank (IDB) in 1975.IDB was established by Saudi Arabia and other
Organization of Islamic Conference (OIC) member countries, with the objective of
fostering the economic development and social progress of the member countries and
Muslim communities individually as well as jointly in accordance with the principle of
Sharia. Despite its multilateral origins, it gave momentum to the Islamic Banking
movement generally, being followed soon afterwards by both private and government
Islamic institutions; for instance, Dubai Islamic Bank established in 1975; Faisal Islamic
Bank, Egypt established in 1977 and Bahrain Islamic Bank established in 1979. An
important development in the 80s is the restructuring of the whole financial system of Iran,
Sudan and Pakistan to accord with Islamic precepts: - Iran in March 1984, Sudan in July
1984 and Pakistan a gradual transition from 1977.
Another important development in the 80s is the establishment of two groups of companies;
Dar al-maal al-Islam in 1981 and Al-Baraka group in 1982. Dar al-maal al-Islam was
founded in Bahamas, headquartered in Geneva and operates 10 Islamic banks, 7 Islamic
investment companies, 7 trading companies and 3 Takaful (Islamic Insurance) companies
in 15 countries around the world while Al-Baraka group was established in Saudi Arabia
in 1982 and currently has activities in 43 countries. It has over 2000 companies including
15 Islamic banks and several Islamic insurance companies. The expansion of Islamic
banking has basically taken two forms:
 Restructuring of the whole financial system of the country to accord with Islamic
precepts as obtain in Iran, Sudan and Pakistan.

16
 Islamic financial institutions operating alongside conventional financial
institutions either autonomously or as ‘window’ within the conventional set up.
In this respect, a number of financial institutions have located at international
level both within and outside of the Muslim countries.
This is the case with banks such as Citibank (U.S.A), ANZ (Australia), ABN Amro
(Netherlands), Goldman Sachs (USA), HSBC (UK), Deutsche Bank (Germany), Societe-
Generale (France), Saudi-American Bank (U.S.A – Saudi), Saudi-British Bank (UK-
Saudi). As it were, there are to date, over 200 Islamic financial institutions in over 70
countries around the world with total asset base in excess of US$230billion (Saidat.A.Otiti,
2018).
Table 1 Evolution of Islamic Banking and Finance in Modern History3
3
Source Khan (1996); IDB (2005)

17
1.1.3 Instruments and Financial products of Islamic Banks
When the Idea of Islamic finance was put into practice on a large scale, few of Islamic
financial instruments did exist. The pioneers of the idea were not given blueprint of Islamic

18
finance in practice. Most of Islamic financial instrument as one sees today were developed
in the daily practices of Islamic finance and banking. From time to time, these instruments
have been developed according to nature of business of particular Islamic financial
institution and needs of particular markets. Since Islamic finance industry is growing
broader and more sophisticated, Islamic financial instruments are also growing in variety.
Although, a great number of financial instruments are claimed as Islamic but not all of
them are acceptable from a strict Sharia point of view. Some of the instruments were not
unanimously accepted and some were rejected by Sharia scholars.
1.1.3.1 Mudarabah (trust financing)
"Mudarabah – Trust financing" is a special kind of partnership where one partner gives
money to another for investing it in a commercial enterprise. The investment comes from
the first partner who is called "rabb-ul-mal", while the management and work is an
exclusive responsibility of the other, who is called "mudarib (Usmani, 1998).
Under the principle of ‘no pain no gain’, no one is entitled to any addition to the principal
sum if he does not share in the risks involved. The Mudarabah’ is a contract, with one
party providing 100 percent of the capital and the other party providing its specialist
knowledge to invest the capital and manage the investment project. The rabb-ul-mal may
specify a particular business for the mudarib, in which case he shall invest the money in
that particular business only. This is called al-mudarabah al-muqayyadah (restricted
mudarabah). But if he has left it open for the mudarib to undertake whatever business he
wishes, the mudarib shall be authorized to invest the money in any business he deems fit.
This type of mudarabah is called 'almudarabah al-mutlaqah" (unrestricted mudarabah).

19
Further, 'Mudaraba' is venture capital funding of an entrepreneur who provides labor while
financing is provided by the bank so that both profit and risk are shared.
1.1.3.2 Musharakah (partnership contract)
The literary meaning of Musharakah is "sharing". The root of the term "Musharakah" in
Arabic comes from the word ‘Shirkah’, which means 'being a partner'. It is used in the same
context as the term "shirk" meaning "partner to Allah". Under Islamic jurisprudence,
Musharakah means "a joint enterprise formed for conducting some business in which all
partners share the profit according to a specific ratio while the loss is shared according to
the ratio of the contribution". It is an ideal alternative for the interest based financing with
far reaching effects on both the production and distribution of wealth in the economy. The
connotation of this term is limited than the term "Shirkah", more commonly used in the
Islamic jurisprudence. For the purpose of clarity in the basic concepts, it is pertinent at the
outset to explain the meaning of each term, as distinguished from the other (Meezan Bank’s
Guide to Islamic Banking, 2018).
1.1.3.3 Murabahah (mark-up)
Murabaha is a particular kind of sale and not a financing in its origin. Since Murabaha is a
sale transaction, rules of Shariah regarding sale should be understood. Where the
transaction is done on a “cost plus profit” basis i.e. the seller discloses the cost to the buyer
and adds a certain profit to it to arrive at the final selling price (Siddiqui, 2016). The
distinguishing feature of Murabaha from ordinary sale is the seller discloses the cost to the
buyer and a known profit is added. This concept refers to the sale of goods at a price, which
includes a profit margin agreed to by both parties. The bank is compensated for the time

20
value of its money in the form of the profit margin. This is a fixed-income loan for the
purchase of a real asset (such as real estate or a vehicle), with a fixed rate of profit
determined by the profit margin. Islamic banks are supposed to take a genuine commercial
risk between the purchase of the asset from the seller and the sale of the asset to the person
requiring the goods. Title to the goods financed may pass to the bank's client at the outset
or on deferred payment.
1.1.3.4 Bai' al 'inah (sale and buy-back agreement)
bai’ al inah refers to an arrangement that involves sale of an asset to the purchaser on a
deferred basis and subsequent purchase of the asset at a cash price lower than the deferred
sale price or vice versa, and which complies with the specific requirements of bai’ al inah
(BNM, 2013). Bai' al inah‟ is a financing facility with an underlying buy and sell
transactions between the financier and the customer. The financier buys an asset from the
customer on spot basis. The price paid by the financier constitutes the disbursement under
the facility. Subsequently the asset is sold to the customer on a deferred-payment basis and
the price is payable in instalments. The second sale serves to create the obligation on the
part of the customer under the facility.
1.1.3.5 Bai' bithamanajil / BBA (deferred payment sale)
A contract that refers to the sale and purchase transaction for the financing of assets on a
deferred and an installment basis with a pre‐ agreed payment period. The sale price will
include a profit margin. This concept refers to the sale of goods on a deferred payment
basis at a price, which includes a profit margin agreed to by both parties. Like ‘Bai'-al-
'inah’, this concept is also used under an Islamic financing facility. Interest payment can

21
be avoided as the customer is paying the sale price which is not the same as interest charged
on a loan.
1.1.3.6 Ijarah (Lease Financing)
Ijarah in Islamic banking and finance can simply mean leasing or hiring. These two
interpretations are used interchangeably in the literature, but the focus in this section is on
the former definition. The term ijarah originates in the Arabic verb ‘ajara’ which denotes
‘rewarding’ or ‘recompensing’. Literally, ijārah is derived from the noun ‘al-ajr’ which
means compensation, reward, consideration, return or counter value (al-‘iwad) against the
use of an object. From a juristic (fiqh) definition, ijarah refers to a contract to utilize a
lawful benefit against a consideration (Al-Zuhayli 2002). In ijarah, the right to use the
object is transferred to the hirer, not its ownership. Hence, ijarah is a sale of usufruct not
of a physical entity. Technically, ijarah is an agreement between two parties, one being the
owner of the asset, who gives possession of the assets for the use of the other party, the
hirer, on an agreed rental over a mutually agreed period. It is also defined as transferring
the usufruct of a particular property to another person in exchange for a rent claimed from
him (Usmani, 2002).
1.1.3.7 ‘Ijarah thumma al bai' (hire purchase)
Literally, Al-Ijarah Thumma Al-Bai’ (AITAB) means to lease, hire, or rent ending with
purchase (Khir, 2008). Researcher Jalil (2013) has given simplest explanation about
AITAB which is ‘hire goods and then purchase’. ISRA (2012) have defined AITAB or
Islamic Hire Purchase is an Islamic vehicle financing feature, which is based on two
combinations of Sharia concepts, Ijarah (leasing) and bay’ (sale). AITAB was first

22
implemented by Bank Islam Malaysia Berhad in 1995 (Abdullah and Dusuki, 2004).
Almost all of the Islamic banks in Malaysia are using AITAB for buying motor vehicles.
But the mechanism of AITAB does not comply 100% Sharia principles. The bank
generates a profit by determining in advance the cost of the item, its residual value at the
end of the term and the time value or profit margin for the money being invested in
purchasing the product to be leased for the intended term. The combining of these three
figures becomes the basis for the contract between the Bank and the client for the initial
lease contract.
1.1.3.8 ‘Ijarah-wal-iqtina’
According to many Islamic financial scholars, the uncertainties of the global economy in
present times have led to many businesses and individuals leaning towards Islamic banking
methods. Grounded in the principles prescribed by the Sharia, these banking practices are
widely perceived to be sound and the financial transactions involved within each,
transparent, easy to understand, and beneficial to all parties who have entered into the
contract. And rightly so. In such a scenario, it is only natural that there should be extensive
research into the working principles and benefits of each mode of Islamic financing, and
particularly the ijara wa iqtina, one of the most popular kinds of ijara lease contracts
(ijaracdc, 2018).
1.1.3.9 Istisna (Manufacturing contract)
Istisna’a is a contract whereby a party undertakes to produce a specific thing which is
possible to be made according to certain agreed-upon specifications at a determined price
and for a fixed date of delivery. This undertaking of production includes any process of

23
manufacturing, construction, assembling or packaging. In Istisna’a, the work is not
conditioned to be accomplished by the undertaking party and this work or part of it can be
done by others under his control and responsibility. Istisna’a, an instrument of pre-
shipment financing and it is a contract where the deal can be referred to something not in
existence at the time of concluding the contract, while Murabaha is an order to buy goods
or commodities which are in existence in hand or possible to be found in the market (ISDB,
2002).
1.1.3.10 Bai Salam
Bay’ al-salam is a sale of an object, which is not available at the time of the conclusion of
the sale, but will be delivered in the future on a fixed future date. The price is, however, to
be paid immediately during the session of the contract. In other words, the transaction is
called bay’ al-salam, when it is a sale for an agreed price with immediate payment for a
determinate thing, to be delivered in the future on a fixed date (Nawawi, 1999). In other
words, salam or salaf is the sale of a deferred item in exchange for an immediate (forward)
price. It is the sale of a liability whose characteristics are described in exchange for a price
or capital-sum paid in advance. The Maliki school defined bay’ alsalam as a sale in which
the capital-sum (price) is paid in advance and the object of sale is deferred to a specified
term. Whereas, the Shafi’i and Hanbali school defined the forward contract as a contract
over described merchandise sold as a deferred liability on one party, in exchange for a price
that is received during the contract session. Bay’ al-salam was allowed by the Holy Prophet
Muhammad s.a.w. subject to certain conditions. The basic purpose of this sale was to meet
the needs of small farmers who needed money to grow their crops and to feed their families
up to the time of harvest. After the prohibition of riba, they could not take usurious loans.

24
Therefore, it was allowed for them to sell the agricultural products in advance (Usmani,
n.d.).
1.1.3.11 Musawamah (Bargaining on Price)
Musawamah is a general and regular kind of sale in which the price of the commodity to
be traded is bargained between the seller and the buyer without any reference to the price
paid or cost incurred by the former. Thus, it is different from Murabaha in respect of the
pricing formula. Unlike Murabaha, the seller in Musawamah is not obliged to reveal his
cost. Both the parties negotiate on the price. All other conditions relevant to Murabaha are
valid for Musawamah as well. Musawamah can be used where the seller is not in a position
to ascertain precisely the costs of commodities that he is offering to sell. From a juristic
point of view, Musawamah can be either cash or credit sale, but when used by banks it will
generally be a deferred payment sale in which they will bargain with clients on the price of
goods/assets. They will add their profit margin to their cost but will not be required to tell
their clients the details of cost price and their profit in any transaction (Shah, 2008).
1.1.3.12 Qard Hassan (Benevolent loan)
In Islam, the principle of Qard al-Hasan is a mechanism for welfare and not for purposes
of business transactions. It is a loan that is free from usury, and given to charitable causes.
The borrower is only required to repay the amount borrowed. (Ahsan 2007) Al-Qard in
Arabic or al-Qat`u means the deduction. It is called qard, as it cut a certain portion of
property lender. Hasan is also the Arabic word, which comes from grace. Ihsan means
loving others. Qard al-Hasan is a loan which is returned at the end of the agreed period
without any interest or share in profit or loss. Qard al-Hasan is a noble act because of non-

25
profit material returns. It is highly encouraged in Islam because it can help people in need
from being oppressed by the borrower. It aims to foster love, brotherhood and unity.
According to Farooq (2007), in financing Qard al-Hasan, an additional amount that is
required is prohibited. However, the borrower can pay more if not specified in the contract.
While there are some differences of opinion on some issues regarding the implementation
of this principle such as the issue of management costs, early repayment according to
demand of creditors, the need for guarantors and others (Wan Nor Aisyah Wan Yussof,
Abdul Ghafar Ismail, Shofian Ahmad , 2015).
1.1.3.13 Takaful (Islamic Insurance)
Takaful Insurance is generally based on the concept that the negative impact of a specific
incident is distributed among a group of persons instead of making the person who
experienced the loss to bear its results alone. The means to achieve this is to establish a
common fund to which everyone exposed to a specific risk may contribute in such a way
that indemnity will be paid from that fund. In this type of insurance, the Insured seeks
guarantee from a group of persons who are participants in the insurance. At the same time,
he supports other members when they are faced with losses. Members who share in this
Insurance insure each other's losses on the basis of legitimate cooperation and Takaful
(Sabbagh, 2012).
1.1.3.14 Hibah (Gifts)
Hibah refers to a transfer of ownership of an asset from a donor (wahib) to a recipient
(mawhub lahu) without any consideration. Gifts to depositors are given entirely at the

26
discretion of the Islamic banks on the basis of the minimum balance. These gifts may be
monetary or non-monetary and are based on the banks‟ returns.
This is a token given voluntarily by a debtor to a creditor in return for a loan. „Hibah’
usually arises in practice when Islamic banks voluntarily pay their customers a 'gift' on
savings account balances, representing a portion of the profit made by using those
savings account balances in other activities. It is important to note that while it appears
similar to interest, and may, in effect, have the same outcome, Hibah’ is a voluntary
payment made (or not made) at the bank's discretion, and cannot be 'guaranteed‟. However,
the opportunity of receiving high, Hibah’ will draw in customers' savings, providing the
bank with capital necessary to create its profits; if the ventures are profitable, then some of
those profits may be gifted back to its customers as, Hibah’.
1.1.3.15 Sukuk’ (Islamic Security)
Sukuk are financial instruments similar to bonds and also shares that are compliant with
Islamic law. Since their inception in 2002, Sukuk markets have experienced dramatic
growth rates attracting the attention of investors, analysts and researchers alike. Accounting
and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines Sukuk as
being: “Certificates of equal value representing undivided shares in the ownership of
tangible assets, usufructs and services or (in the ownership of) the assets of particular
projects or special investment activities.”4
4
The AAOIFI Shari'ah Standard (17) on investment Sukuk

27
There are three requirements for a Sukuk to be considered in compliance with the Sharia
law5
. First, the certificates must represent ownership in tangible assets, usufructs or
services from revenue-generating firms. Second, payments to the investor come from after-
tax profits and third, the value repaid at maturity date should follow the current market
price of the underlying asset and not the original invested amount. Sukuk comes in many
different forms, as financiers are not restricted to create their own variations (Visser, 2009),
However, fundamentally the parties within a Sukuk issuance are the firm (the obligor or
originator), the Special Purpose Vehicle (SPV)and the investors that buy the Sukuk. The
SPV is a bankruptcy-remote entity, separate from the originator, which issues Sukuk
certificate.
1.1.3.16 Islamic equity funds
Islamic investment equity funds market is one of the fastest-growing sectors within the
Islamic financial system. Currently, there are approximately 100 Islamic equity funds
worldwide. The total assets managed through these funds currently exceed US$5 billion
and is growing by 12–15% per annum. With the continuous interest in the Islamic financial
system, there are positive signs that more funds will be launched. Some Western majors
have just joined the fray or are thinking of launching similar Islamic equity products.
Despite these successes, this market has seen a record of poor marketing as emphasis is
on products and not on addressing the needs of investors. Over the last few years, quite a
5 Godlewski, C, Turk-Ariss, R, & Weill, L. ,Sukuk vs. conventional bonds: A stock market

28
number of funds have closed down. Most of the funds tend to target high net worth
individuals and corporate institutions, with minimum investments ranging from
US$50,000 to as high as US$1 million. Target markets for Islamic funds vary; some cater
for their local markets, e.g, Malaysia and Gulf-based investment funds. Others clearly
target the Middle East and Gulf regions, neglecting local markets and have been accused
of failing to serve Muslim communities.
1.1.4 Retail Islamic Banking Products
There are three types of account which are commonly known in the Islamic Banks. These
are: Current Account, Saving Account and Investment account. The Sharia principles
applicable to current account is Alwadiah while saving account are Alwadiah, Mudarabah
and AlQard Hassan. However, AlQard is commonly offered by Islamic banks in the Middle
East. The Sharia compliant of current account based on the Alwadiah Yad Dhamanah (safe
custody) principle which refers to a contract between the owner of funds (account holder)
and the bank for safe keeping purposes.
1.1.4.1 Current Account/deposit
Alwadiah Current Deposit is a deposit product operated according to Islamic Sharia where
the depositor will deposit money in the Bank in the form of ‘Amanat’ and thus expects on
profit or loss. The Bank takes permission from the depositor to use the deposit according
to Islamic Sharia but guarantees that the amount deposited would be available to depositors
whenever s/he demands. If Bank does loss using this deposit, then bank will incur all

29
responsibilities. Since depositors do not take any risk of loss, so they cannot demand any
profit (TrustBAnk, 2018).
Current deposit account is a form of demand deposit that offers users safe keeping of their
cash deposit, and the choice to be paid in full upon demand. Current account deposit
facilities are usually offered the either individuals or companies. It also shares similar
features with saving deposit as it permits for the cash to be withdrawn at any time. The
main point of departure between current deposit and s saving deposit is the presence of
cheque book and multi-functional card used in the former.
If the account holders were to withdraw more than what is sufficient in their balance, there
will also be no charges incurred. In the US, current deposit is prominently known as
checking account or demand deposit. The three common structures of a current deposit in
Islamic financial are Qard wadiah yad dhamanah and mudarabah current deposit.
Generally, no return is given in this deposit in the ground that such deposit takes the form
of loas given to Islamic banks and the loan cannot carry any return. They are kept as
amanah. Bank shall guarantee the principal amount of deposit. A further condition for such
such an incentive is that they should not to be offered regularly. This is because, with the
passage of time, the practice will become customary and, in return, take on ruling benefits
stipulated in a contract of deposit (Ayub, 2007)
1.1.4.2 Savings Account/deposit
Alwadiah’ structures are also used for higher return savings account. Banks may as they
see fit pay the savers a return, depending on their own profitability. This seems to be
allowed as the bank's payment, if any, is level and is not determined in advance. All Islamic
bank operate savings deposit account, however, the operation of these accounts vary at

30
different banks. Generally, a saving deposit permits costumer to deposit and withdraw their
money at any time and does not require a minimum balance in deposit account. It does not
have maturity date; therefore, the cash can be withdrawn at any time based on the
costumer’s demand (Irsyid, 2007). Generally, Islamic financial institution structure their
saving deposit account based on sharia principle, either form of qard, wadiah yad damanah
or mudarabah saving deposit.
1.1.4.3 Investment Account/deposit
The investment deposit is usually known as profit and loss sharing (PLS) account or
simply, the investment account. The ratio of profit distribution between the bank and
depositor shall be agreed at time of accounting opening subject to the sharia that a partner
may agree on ration of profit and losses have to be shared strictly in the ratio of capital
(Ayub, 2007). The main point of departure between the investment deposit and both saving
and current deposit is the former is normally structured based on either the Mudarabah and
Wakalah bi istismar principle which do not entail a guarantee of either principal or the
return of profit. Nevertheless, the investment account holders have an opportunity to earn
more attractive returns although there is also like hood having to bear the risk of capital
losses (ISRA, 2013).
1.1.5 Islamic Laws on Trading
The Qur'an prohibits gambling (games of chance involving money) and insuring one’s
health or property (also considered a game of chance). The hadith in addition to prohibiting
gambling (games of chance), also prohibits 'bayu al-Gharar' (trading in risk, where the
Arabic word ''Gharar'' is taken to mean "risk" or excessive uncertainty). The 'Hanafi

31
madhab' (legal school) in Islam defines ''Gharar'' as "that whose consequences are hidden."
The Shafi legal school defined ''Gharar'' as "that whose nature and consequences are
hidden" or "that which admits two possibilities, with the less desirable one being more
likely." The Hanbali school defined it as “that whose consequences are unknown” or “that
which is undeliverable, whether it exists or not”. Ibn Hazm of the Zahiri School wrote
''Gharar is where the buyer does not know what he bought, or the seller does not know what
he sold”. The modern scholar of Islam, Professor Mustafa Al-Zarqa, wrote that Gharar is
the sale of probable items whose existence or characteristics are not certain, due to the
risky nature that makes the trade similar to gambling. Other modern scholars, such as Dr.
Sami al-Suwailem, have used Game Theory to try and reach a more measured definition
of Gharar defining it as "a zero-sum game with unequal payoffs".
1.1.6 What is Islamic Forex Trading?
Shari’a – Islamic - law, prohibits interest payments (forex-learning-site, 2013;
dailyforex.com, 2013). However, rollover interest6
is an integral part of forex trading:
So the question on one Islamic forex website is:” How can a Muslim forex trader
from Saudi Arabia or United Arab Emirates trade currencies without violating
religious/Sharia law? The answer is to find a forex broker willing to offer an
‘Islamic’ forex account with no overnight interest. Such swap-free accounts are
usually offered only to Muslims in order to prevent widespread abuse. To substitute
6
Rollover Interest: Rollover is the interest paid or earned for holding a position overnight. Each currency has an interest
rate associated with it, and because forex is traded in pairs, every trade involves not only two different currencies, but also
their two different interest rates. If the interest rate on the currency bought is higher than the interest rate on the currency
sold, then rollover is earned (positive roll). If the interest rate on the currency bought is lower than the interest rate on the
currency sold, then rollover will be paid (negative roll). Rollover can add a significant extra cost or profit to a currency
trade (Murphy, 2009).

32
for the revenue from a missing swap, Islamic forex brokers charge a flat fee for
this service” (forex-learning-site, 2013 online). As explained by Islamic forex
brokers: “If you are Muslim respectful of religion, you want to trade currencies here
is the solution that is halāl. Here is a list of the best forex brokers offering an Islamic
trading account to Muslim customers. An Islamic account allows Muslim traders to
open accounts without interest during the night, which is not prohibited
by Islamic law Sharia (topforexbrokersonline,2013online).
1.1.7 Risk Management in Islamic Banks
Risk arises when there is a possibility of more than one outcome and the ultimate outcome
is unknown. In business Dictionary risk is defined as a probability or threat of damage,
injury, liability, loss, or other negative occurrence that is caused by external or internal
vulnerabilities, and that may be neutralized through preemptive action.7 According to
Wikipedia, ‘Risk is a concept that denotes a potential negative impact to some
characteristic of value that may arise from a future event, or we can say that "Risks are
events or conditions that may occur, and whose occurrence, if it does take place, has a
harmful or negative effect’. Exposure to the consequences of uncertainty constitutes a risk.
In everyday usage, risk is often used synonymously with the probability of a known loss.
Also (Ross, Westerfield and Jordan -2007) explained that risks can be classified into
systematic and unsystematic components. The systematic risk is one that influences a large
number of assets, each to a greater or lesser extent. Because systematic risks have market
wide effects, they are sometimes called market risks. The unsystematic risk is one that
affects a single asset or a small group of assets. Because these risks are unique to individual
companies or assets, they are sometimes called unique or asset-specific risks.

33
1.1.7.1 Different types of risks in Islamic banking
Islamic banks carry different types of risks, some of them exists only on any Islamic banking. And
others are common between both Islamic and conventional banks (Thijs, 2012)
The below figures clarifies both types and a definition of each type:
Table 2: Different types of risks7
Types of Common risks Both Islamic and conventional banking
Credit risk The potential that a counterparty fails to meet
its obligations in accordance with agreed terms
and conditions of a credit-related contract
Market risk The potential impact of adverse price
movements such as benchmark rates, foreign
exchange rates, equity prices on the economic
value of an asset
Liquidity risk The potential loss arising from the Bank’s
inability either to meet its obligations or to fund
increases in assets as they fall due without
incurring unacceptable costs or losses
Operational risk The potential loss resulting from inadequate or
failed internal processes, people and system or
external events
Types of Unique risks Islamic banking Only
7
Source: Jeroen P.M.M. Thijs, Chief Risk Officer. risk management in Islamic banking. bank Islam Malaysia Berhad

34
Sharia noncompliance risk Risk arises from the failure to comply with the
Sharia rules and principles
Rate of return risk The potential impact on the returns caused by
unexpected change in the rate of returns
Displaced Commercial risk The risk that the bank may confront
commercial pressure to pay returns that exceed
the rate that has been earned on its assets
financed by investment account holders. The
bank foregoes part or its entire share of profit
in order to retain its fund providers and
dissuade them from withdrawing their funds
Equity Investment risk The risk arising from entering into a
partnership for the purpose of undertaking or
participating in a particular financing or
general business activity as described in the
contract, and in which the provider of finance
shares in the business risk. This risk is relevant
under Mudarabah and Musharakah contracts.
Inventory risk risk arising from holding items in inventory
either for resale under a Murabaha’ contract, or
with a view to leasing under the ijarah contract

35
1.2 Financial institutions in Somalia
Somalia’s financial system has been decimated by two decades of conflict. In January
1991, all state institutions that provided services and regulated the economy collapsed,
including the Central Bank of Somalia and the entire banking system. The commercial
bank liabilities that had survived the 1989 bankruptcy of the only commercial bank in the
country disappeared. The country has also been suspended from accessing global financial
markets, a situation that compromises the leverage of the Transition Federal Government
(TFG) in domestic as well as international financial markets8
. The situation in Somaliland
provides a more detailed view of the incipient nature of financial services in Somalia. The
Bank of Somaliland, which was in its inception a regional arm of the Central Bank of
Somalia, currently operates itself under a Somaliland 1994 “Constitutive Law”. So far, the
Bank of Somaliland is not in a position to perform key central bank functions, as it has not
developed the typical in addition, past circulation of counterfeit currency (by individuals)
has led to inflation and hyperinflation and an increasingly dollarized system within the
Somali economy. In December 2006, the Central Bank of Somalia reopened its offices in
Mogadishu and Baidoa, but it continues to have limited functionality. It is operating under
Decree Law No 6 of 18 October 1968 (although a draft Central Bank Bill and Banking Bill
have been developed). An incipient central banking authority has evolved in Puntland and
Somaliland, through two regional banks. These have several branches and offer some
commercial banking services, such as deposit accounts and trade finance. While their
primary function as central banks remain (as it should be) acting as the treasurer of their
8
Somalia relations with international creditors were frozen in late 1980s. As of 2007, Somalia’s national debt stood at
US$ 3.3 billion (of which 81% is arrears), comprising 40% owed to multilaterals, 46% owed to Paris Club creditors and
14% owed to non-Paris Club creditors.

36
respective regional governments, the fact that they also offer commercial banking services
creates an undesirable conflict of interest with their role as central banks (ICS, 2010).
1.2.1 RIEF HISTORY OF THE SOMALI FINANCIAL INSTITUTIONS
Following are the banks operated in Somalia and owned by foreign investors and public
entities (CBS, 2018):
1920: The first bank opened in Southern Somalia was the Banca d’Italia (Central Bank of
Italy) which established its branch in Mogadishu.
1925: The bank opened also another branch in Kisimayo on the 2nd
November 1925.
1930: The British Government opened in Northern Somalia the Government Savings Bank
with the objectives to encourage the people to save parts of their
income
1932: In Mogadishu a branch of Cassa di Risparmio di Torino, an Italian Commercial
Bank, opens its office.
1936: A branch of Banco di Roma, an Italian commercial bank, was
established in Mogadishu. In the same year Banca d’Italia opened its third branch in
the city of Merca.
1938: Banco di Napoli took over the branch of Cassa di Risparmio di Torino branch in
Mogadishu.
1941: All Italian banks were closed by the British Administration.

37
1943: The Barclays Bank DCO, a British Commercial Bank, was opened in Mogadishu,
This Coincides when the British Government Army took control the southern regions of
Somalia.
1950: Italian commercial banks, such as Banco di Roma and Banco di Napoli re-ope-ned
their branches in Mogadishu.
1950: The Italian Trusteeship Administration (A.F.I.S.) established on 8th
April, 1950 a
new currency institution regulator “Cassa per la circolazione monetaria della Somalia”
with its head quarter in Rome. Main functions of the new institution were:
 Treasury services
 Advances to A.F.I.S. for short term loan
 Issuance of circular cheques and current accounts cheques
 Acceptance of deposits from the public
 Buy and sell foreign currencies and gold
 Buy and sell government bonds
 Re-discount commercial bank’s bills
 Invest its assets, except cash kept as guarantee
The establishment of two public commercial banks.
On the 1st
January, 1971 two commercial banks were established:
 Somali Savings and Credit Bank
 Somali Commercial Bank

38
1952: In Hargeisa for the first time was opened a branch of National Bank of India, a
commercial bank owned by the British Government.
1954: The National Bank of India opens another branch in Berbera.
1954: In Mogadishu was established the first Government owned bank the “Credito
Somalo” founded by Decree No.2 of 22 February 1954 issued by A.F.I.S.; its main
objectives were to extend financial support to the small farmers, livestock, and small scale
industries and handcrafts sectors. By Law No. 10 of 30 September 1956 the Credito Somalo
was authorized to accept savings from the customers. According to the Law No.28 and 29
dated August 1957 and Law No.1 of 18 February 1959, within the Credito Somalo were
established two autonomous departments: housing credit Department, and medium and
long term loans facilities Department. The capital of the Credito Somalo was So.Shs.
7,500,000 of which So.Shs. 6,300,000 was paid by A.F.I.S. and A.S.E.S. (Agency for
Economic Development of Somalia), and So.Shs. 1, 200, 000 paid by banana plants
cultivators companies (S.A.C.A. and S.A.G.). The bank opened also branches in Kisimayo,
Baidoa and Merca.
1960 Was established the Central Bank of Somalia named “Somali National Bank” by
Decree No.3 of 30 June, 1960 and converted into Law No.2 of 13 January, 1961.
The Somali National Bank has been authorized to extend to its activities to all the regions
of the Republic of Somalia and opened the following branches:

39
Hargeysa 20 August 1961
Berbera 27 January 1962
Kismayo 5 November 1962
Bosaso 26 March 1963
Qardho 26 March 1963
Burao 29 March 1963
Galkaio 5 November 1963
Baidoa 4 January 1965
Beled Weyne 6 January 1965
The Somali National Bank being a Central Bank was not allowed to carry commercial
banks operations, but, due of non-presence of commercial banks in most of the regions of
the country, the Government of Somalia enacted Decree No.264 of 3 November, 1962
authorizing the Somali National Bank the authority to engage in commercial banking
operations.
1961: Banque de Port Said, an Egyptian commercial bank, opened a branch in Mogadishu,
and operated until 7th of May, 1970.
1968: The Somali Development Bank was established by Decree No.2 of 28 February
1968. Art.3 of the Law states that the bank main purpose to its establishment is to play a
significant financial role to all economic sectors in medium and long term loans, in
particular agriculture, industry, mining and tourism. The Somali Development Bank as per

40
Art. No. 5 of its foundation act was not allowed to accept deposits or savings from the
depositors.
1968: in Mogadishu the National and Grindlays Bank established a new branch and also
the bank were operating in Hargeysa and Berbera.
1968: The Credito Somalo was closed due of liquidity crises and all its assets and liabilities
were transferred the to the Somali National Bank. The two banks were autonomous
institutions with legal personalities and a capital of So.Shs. 2,500,000 each of which 50%
paid by the Somali Government and 50% by the Central Bank of Somalia. The two
institutions were fully owned by the Government, with same objectives and activities
(commercial banks), their operation were based on deposits and savings and short term
loans. In 1975 there was a change to the structure of banking system in Somalia. The two
commercial banks were amalgamated into the Commercial and Savings Bank of Somalia,
at the same time, the Somali National Bank was renamed the Central Bank of Somalia. In
1990 following an agreement with the I.M.F. on 1st
July, 1990 implementing the free
private oriented economy, a new commercial bank was established “Somali Commercial
Bank” by Presidential Decree No. 4 of 16 December, 1989, with a capital of So.Shs. 2
billion divided into two thousand shares of one million So.Shs. Each. One billion was paid
jointly by the Government and the Central Bank of Somalia and one billion left to the
private investors of which only 22 shares were subscribed.
Finally, the under listed banks were operating in Somalia at 30 December, 1990:
1. Central Bank of Somalia.
2. Commercial and Savings Bank of Somalia.

41
3. Somali Development Bank.
4. Somali Insurance Company.
1.2.2 Current profile of Financial Sector in Somalia
Somalia has been without a formal commercial banking and financial institutions sector
since the overthrow of Siad Barre’s government in 1991. Immediately prior to the civil
war, Somalia’s formal financial sector was composed of:
 Central Bank of Somalia
 Commercial and Savings Bank
 Somali Development Bank; and
 Somali Insurance Company.
At present the financial sector is composed of the Central Bank of Somalia, Somali
Remittance Companies, and Micro-finance institutions (as pilot projects in the North-
Western Regions-Somaliland and in the North-Eastern Regions-Puntland).
Regulation
The Central Bank is currently operating under the 1968 Act, No. 6 of 19th October, which
specifies the roles and responsibilities of the Central Bank. These include acting as a fiscal
agent to the treasury, supervising commercial banks and others financial institutions,
issuing currency etc (FoA, 2018).

42
Money supply:
In the absence of formal commercial banking activities, the credit creation and therefore
money creation by the commercial banks does not exist in the economy at present. Under
such circumstances, all economic transactions in the country are being handled through
cash payment to settle obligations in domestic trade, including transactions that involve
large sums of cash, which could have been otherwise settled through other means.
Inflation and exchange rates:
The economy is deeply dollarized in view of weak confidence in the local currency, with
prevalent use of counterfeits. Alongside the Somali shilling, the US dollar is widely
accepted as a medium of large and high value transactions even for local trade exchange.
Remittance Companies.
The Remittance companies supported with spin-off activities in telecommunication sector
are the main medium for much of the hard currency movements to and from the country
and they provide the infrastructure of trade and commerce in Somalia and abroad. The
remittance companies are the only financial services providers in the country for the
majority of households and for the whole for the private sector.
No commercial banks are operating in Somalia. It has been reported that some regional
banks are in discussions with the Somali Remittance Companies with regard to joint
ventures. The local Somali business community is also exploring the possibilities of
launching commercial banks that could also provide service to the private sector.

43
Challenges facing the Financial sector of Somalia (Jama, 2018)
The following are challenges facing the financial sector of Somalia
1. The insecurity resulting from the civil war
2. Lack of an effective formal banking sector.
3. Lack of effective financial operating framework
4. Lack of skilled staff
5. Inadequate legal framework
6. There is no formal financial sector in the country
7. Lack of stock market and securities exchange
8. Lack of insurance companies
9. Weak regulatory framework
10. Inadequate security
11. High operation cost
1.3 Islamic Banks in Somalia
The Islamic banking and finance industry has been growing at an exponential pace
generally, with assets displaying a robust growth of about 15-20 percent annually. As
Somalia endeavors to reconstruct its shattered economy, a viable commercial banking
sector will be crucial. Many literatures propose that a well-developed financial system
plays an independent role in encouraging long run economic growth. Somalia financial
system is growing faster in the last few years. As of now, there are six licensed Islamic
banks in Somalia (CBS) five of which are from Mogadishu and one from Garoe (Amal

44
bank). It is believed that there are more than these registered ones since the other
autonomous states have their own central banks. Somaliland, which is a self-declared state,
has its own central bank that runs and regulates its financial affairs. In addition, there are
14 Hawala, which is a method of transferring money without any actual movement.
Transactions between Hawala brokers are done without promissory notes because the
system is heavily based on trust. Another institution, which is prominent in Somalia, is
Takaful Company “Islamic insurance” (Jama, 2018).
1.3.1 Commercial Versus Islamic Banking in Somalia
Conventional commercial banks prefer to lend to low-risk activities and are reluctant to
finance high risk projects, even if such projects present better investment opportunities and
they are less willing to finance small firms that don’t have adequate collateral. In contrast,
fostering serious economic development is an inherent key objective of Islamic banks as
they seek to maximize social benefit. Islamic banks should therefore work hard to
overcome shortages and difficulties to help the economy to progress to a higher stage of
self-sustained development, resulting in a favorable effect on socio economic harmony due
to equal income distribution. From above analysis, it is obvious that Islamic banking
system is more suitable to the financial services needs of Somalia due to its dire need for a
financial system with strong inclination to social justice and financial inclusion. In the
coming section, we will briefly look at the underpinning principles of Islamic finance with
the objective of evaluating its suitability to Somalia’s financial services’ needs. Both
conceptually and theoretically Islamic finance is rich in certain desirable socio-economic
goals such as social justice, equity, the alleviation of poverty and human well-being
(Chapra, 1985). The modern conventional banking system in Islamic countries is a product

45
of colonizers using the support of financial institutions for mining, agriculture and
manufacturing (Beck & Levine, 2003). The initial banks were predominantly used for the
funds of foreigners and as a means to increase foreign owned industries that spread through
imperial rule. We will now be looking at the available options for Somalia in this respect
with the objective of evaluating the various possible models of establishing a practical,
sustainable and feasible banking system in Somalia. However, it is worth noting in this
context that Somalia had no central monetary authority for over fifteen years between the
outbreak of the civil war in 1991 and the subsequent reestablishment of the central bank of
Somalia in 2009. Paradoxically, the nation’s payment system is fairly advanced primarily
due to the wide spread existence of private money transfer operators that have acted as
informal banking networks. Hence, one of the quickest and the most practical ways of
establishing a functioning banking system in Somalia is the conversion of the existing
Hawala companies into Islamic banks as we will discuss in the following section
(Warsame, 2016).
1.3.2 Islamic Finance education in Somalia
Somalia education system is privatized since the collapse of the central government in
1991. Prior to Somali civil war, the government mainly controlled the education system.
Somalia had only one public university located in Mogadishu and enrolled approximately
4000 students each time (Hoehne, 2010). Currently, there are more than 50 higher
education institutions of different sizes and capacities functioning across the country
(HEIs). These institutions enroll over 50,000 students; especially given the prolonged
periods of insecurity experienced in parts of the country they lack regulation and quality
control. In 2014, the Somali National University was reopened. The number of schools and

46
universities increased rapidly in a short period. The commencement of university courses
is based on the demand of the students who can afford the tuition fees charged according
the founder’s desire. Islamic finance education was formerly taught in the mosque mainly
by the Somali clerics and was focused on the Shari’ah aspect of transactions, but was
lacking in the financial and law aspects of the transaction. Despite the growth of Islamic
banks in Somalia, higher education learning has yet to tap into the growing need for Islamic
finance education. There are two universities offering IFE in Somalia currently. These are
Darul Hikmah University and Badar Universities. Darul Hikmah University has its
program under INCEIF global university of Islamic finance in Malaysia. The first batch of
around 50 students graduated from this university. The courses are designed by INCEIF
and the mode of study is online, but Darul Hikmah University only coordinates the
program. The other university is Badar University in Somaliland, which offers degrees in
Islamic banking and finance. Unlike Darul Hikmah University, this university plans its
own curriculum and disseminates learning to students. Apart from these two universities,
some colleges and institutions offer diploma and certificates of one-year duration and offer
some seminars and counseling to the industry players in some regions (Jama, 2018).
1.3.3 Opportunities of Islamic Banking in Somalia
Most of the universities in Somalia now offer courses in conventional banking and finance
and yet there are no conventional commercial banks in Somalia. The graduates of these
programs would have difficulty during the employment process. However, Islamic finance
can take advantage to boost this emerging industry. The Somali people, due to their faith,
favor ethical based financing and transactions. In addition to this, about 100% of Somalians
are Muslims, which serves a basic platform for Islamic Finance to grow. Since there is

47
sanity coming up in the polity now, this will be an added benefit for IFB industry to
establish their operations in the country. To conclude, this review will support the objective
of making Somalia becomes a financial hub in East Africa. There is a vital demand for
academic and practical training in this developing sector. However, lack of harmonization
of curriculum and regulations between the universities remains a challenging issue. This
may create obstacles to the development of Sharia compliant banking system (Jama, 2018).
1.3.4 Products of Islamic Banks in Somalia
Islamic Banks in Somalia offer an Islamic savings and current accounts. The savings
accounts offer profit sharing and can be specialized in specific sectors of the economy,
upon the client wish, while current account is for everyday money usage. FSB Islamic loan
products are geared towards larger projects, like building and renovation financings. Trade
Financings are also available to facilitate importing goods to the Somali market.
 The bank can finance new real estate (property development) by Istina,
 Financing of old real estate is set up through Diminishing Mushakara,
 agriculture production is financed by Salam contracts,
 Equipments are financed through Murabaha Purchase Order financing,
 Business Expertise like running a restaurant is financed by Mudaraba financing.
Clients can also invest in safe fixed return products like Treasury Murabaha deposits
accounts or by investing together with the bank in some of its associated business
(Musharaka) like Islamic finance operator (Takaful), which are riskier but carry more profit
rates if it is successful. The bank’s aim is to move Somalia towards modern and more

48
secure cashless society together with the mobile phone and internet-based banking facilities
(FSB, 2012).
1.3.5 Growth of Islamic Finance in Somalia
In 1970s was the time that Islamic banking system emerged in Somalia. Islamic Banking is interest
free banking governed by the principles of Islamic Shari’ah (LAYLA ABDULLAHI, MOHAMED
HASSAN, AMIN HASSAN, 2016) .In the modern era Islamic banking is growing very fast due
to its optimistic impact on every individual, industry and the economy as a whole. As
Islamic banking is not only covering the credit worthiness and the ability to pay the loans
and the profits as and when it is due, it also increases the worth of the project which is
directly proportionate to the profit of the project. Ultimately, projects grow at a rapid speed
and business are getting bigger and bigger (Shahzad, 2012).
1.4 Challenges Facing Islamic Banking Services
1.4.1 Lack of Awareness and understanding
Despite the growth of Islamic banking over the last 30 years, one of the main challenges
facing Islamic banking is the poor understanding about its operations in the Muslim and
non-Muslim world.
1.4.2 Regulatory Challenges
The relationship between Islamic banks and monetary authorities is a delicate one.
Whatever the goals and functions are, Islamic banks came into existence in an environment
where the laws, institutions training and attitude are set to serve an economy based on the
principles of interest. For example, the operations of Islamic banks are on a profit and loss
share basis (PLS), which actually does not come fully under the jurisdiction of the existing

Islamic Banking in Somalia; Challenges and Opportunities

Islamic Banking in Somalia; Challenges and Opportunities

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