Islamic Modes for Agricultural Financing PRODUCTS

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Islamic Modes for Agricultural Financing
PRODUCTS Murabahah and Salam Lahore 16 17
May, 2008 Al Huda Training Programme

• Muhammad Khaleequzzaman
• Head Islamic banking Department
• Intl Islamic University Islamabad

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Islamic Modes Agricultural Financing

• Agricultural production Cycle - Crops

STAGE
ACTIVITY
Acquisition of land/ Choice of crop
Entering Contract of cultivation in case of
rented land, decision about crop in view of
market demand
Preparation of land
Clearing, Leveling, Plowing, Seed bed
preparation, Installation of Irrigation/drainage
system
Crop production operations
Sowing/transplantation, Irrigation,
Fertilization, Weeding, Pesticide application
Harvesting
Cutting/ picking, threshing
Post harvest Marketing
Cleaning, Grading, Processing, Packing, Storage,
Transportation, Sale of produce
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Islamic Modes Agricultural Financing

• Areas of Financing (including crop production)
• Working Capital (Short term)
• Crop production Purchase of inputs i.e. seeds,
  fertilizers, pesticides, etc. Murabahah
• Poultry Farming purchase of feed/raw material,
  birds/chicks, vaccination/medication, utensils,
  etc. Murabahah
• Dairy Farming purchase and production of
  feed/fodder, milk container, vaccination/medicatio
  n, utensils, etc. Murabahah
• Fish Farming purchase of fuel, ration,
  processing Murabahah equipment, purchase of
  handling and storage boxes, etc.
• Liquidity Requirement repair maintenance of
  machinery equipment, labor/water/utility
  charges, etc.) Salam

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Islamic Modes Agricultural Financing

• Areas of Financing (including crop production)
• Term Financing (medium and long term
• Farm Mechanization Purchase of tractor and farm
  machinery for tillage, sowing/planting, pesticide
  application, harvesting/threshing, etc.
  Murabahah/ Ijarah
• Transport purchase of trailers, reefer vans,
  milk cooling/ chiller tanks/carriers,
  motorcycles/pickups, of feed/raw material,
  birds/chicks, vaccination/medication, utensils,
  etc. Ijarah/Diminishing Musharakah
• Live stock purchase/replacement of animals for
  milk meet production, refrigerated storage,
  animal sheds, water supply system, generator,
  fencing slaughter house etc. Murabahah/DM/Istisn
  a
• Irrigation System t/wells, sprinkler/drip/solar
  pumps, water course lining, etc.
  Ijarah/Murabahah/DM/ salam
• Forest development and enhancement nursery
  raising, tree plantation, etc. DM

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Islamic Modes Agricultural Financing

• Areas of Financing (including crop production)
• Term Financing (medium and long term
• Poultry Farming construction of breeding
  hatchery farms, utensils, feed mills, transport
  distribution vehicles, slaughtering processing,
  etc. Murabahah/ DM
• Fish Farming/catching construction of fish ponds
  hatcheries, purchase/replacement of fishing
  boats, engines, and related facilities
  equipments, construction of cold storage, etc.
  Murabahah/DM
• Dairy Farming milk processing, plants, etc.
  Murabahah/DM/Ijarah
• Miscellaneous green houses, godowns,
  dairy/livestock farms, seed/milk/fruits/vegetables
  processing equipment

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Islamic Modes Agricultural Financing

• BLANK SLIDE

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Training Workshop Islamic Microfinance

• ISLAMIC MODES/INSTRUMENTS
• Sale Contracts
• Murabaha/Murabahah to the Purchase Orderer
• Salam/Parallel Salam
• Istisna/Parallel istisna
• Participatory Modes
• Mudarabah/Resource Mobilization
• Musharakah/Diminishing Musharakah
• Rent based Modes
• Operating ijarah
• Ijarah wa iqtina

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Theory Practice of Murabahah

• Preliminary Rules applicable for Islamic Sale
• Subject (good to be sold) must exist at the time
  of sale
• Subject must be in ownership of seller Physical
  or constructive possession exception in Salam
  and Istisna
• Subject must be property of value
• Subject should be halal
• Subject must be known and identified
• Sale must be instant and absolute
• Sale must be unconditional
• Delivery of sold item must be certain
• Price of subject must be certain
• Risks and responsibilities attached with the
  subject must transfer from seller to the
  purchaser as a result of sale

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Training Workshop Islamic Microfinance

• Preliminary
• Murabahah historical perspective
• Murabahah and Musawamah
• Spot and Deferred Murabahah
• Deferred Murabahah and Bai Muajjal
• Banking Murabahah

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Theory Practice of Murabahah

• Murabahah Concept and Historical perspective
• Murabahah defined
• Selling a commodity as per the purchasing price
  with a defined and agreed profit (Ribh means
  profit).
• Profit may be a percentage of the selling price
  or a lump sum.
• The transaction may be concluded with or without
  any promise in which case it shall be called as
  ordinary Murabahah or banking Murabahah or
  Murabahah to the purchase orderer.
• Shariah Legitimacy of Murabahah
• Quraan Surah Ale Imran It is no crime for
  you to seek the bounty of your Lord verse
  198
• Surah Al-Baqarah Allah has permitted trade
  Verse 275
• Sunnah The Prophet (PBUH) purchased a she camel
  from Abu Bakr (RAA) for use as transportation
  from Medinah...

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Theory Practice of Murabahah

• Process FlowPromise Stage
• Negotiation/Approval of overall limit
• MOU/Master Murabahah Facility Agreement
• Requisition Undertaking Security Deposit
  (Hamish jiddiyah)

2
MOU/Master MFA
Bank
Client
Approval of Limit
1
Requisition, Undertaking, Sec. Dep.
3
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Theory Practice of Murabahah

• Agency Stage
• Third party appointed as agent Optional
• Clint can be appointed agent case of dire need
• Payment to the Supplier Direct

Draft of Payment
2 A
Agent (Client)
3
Bank
Client
Bank
Agent (3rd Party)
Receipt of Payment
Receipt of Payment
2
1
Agency Agreement
Agency Agreement
Supplier
Supplier
Supplier
3
Payment
2
Payment
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Theory Practice of Murabahah

• Acquisition/Possession Stage
• Constructive Possession
• Payment to supplier
• Discount of supplier/benefit to client
• Title of goods
• Transfer of risk and responsibilites

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Theory Practice of Murabahah

• Execution of Murabahah / second Sale
• Receipt / Possession report
• Offer of client to purchase
• Acceptance of offer by the bank
• Return of security deposit
• Collateral obtained
• Delivery of goods / Transfer of Risk
  responsibility
• Ownership changes
• Payment of earnest money (Urboun) Optional
• Payment of Murabahah Price
• Client pays Murabaha price as per agreed schedule
• Collateral released
• Murabahah terminates

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Theory Practice of Murabahah

• Execution of Murabahah

Urboun/Securities
4
2
Offer to Purchase
Client
Bank
Acceptance of Offer
3
Receipt , Possession Report
1
Sec. Deposit/Hamish jiddiyah
3
DP Note

• Payment of Murabahah Price

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Theory Practice of Murabahah

• Purchase of poultry feed stock
• Murabahah transaction Rs. 100,000
• Murabahah Facility 90 Days
• Payment Lump sum
• Rate of Profit Six months KIBOR2
• Freight 5 of cost of goods
• Securities Pledge of feed stock, post
  dated cheques

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Theory Practice of Murabahah
Pricing of Murabahah Example
Particulars Amount (Rs.) Amount (Rs.)
Cost of goods Rs. 100,000
Rate of Profit Kibor 2
Six monthly KIBOR 10 p.a.
Freight/Insurance 5 of cost
Total cost 100000 x 5 100000 5000 105000
Profit 102 12 p.a. 105000 x 12 x 90/365 3107
Murabahah Price 1050003107 108107
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Theory Practice of Murabahah

• Issues in Murabahah
• Oral promise/unilateral bilateral promise with
  option
• Suppliers price in the name of customer/without
  any name/banks discretion (offer to negotiate)
• Prior contractual relationship (customer and
  supplier)
• Vendor being third party buy back (inah)
• Commitment or credit facility fee
• Documentation charges
• Syndication charges
• Feasibility study fee
• Performance guarantee from customer in case the
  vendor is of its choice

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Theory Practice of Murabahah

• Issues in Murabahah
• Hamish Jiddiyah/trust/return/investment
• Arboun/ treatment/timing
• Sequence of transactions
• Timing of promissory note
• Rollover in murabahah
• Timing of executing murabahah
• Default by the client
• LIBOR/KIBOR being reference price
• Rebate on early payment

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Islamic Modes Agricultural Financing

• BLANK SLIDE

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Islamic Modes/Instruments - Sale Contracts

• Salam Defined
• A salam transaction is the purchase of a
  commodity for deferred delivery in exchange for
  immediate payment. It is a type of sale in which
  the price, known as the salam capital, is paid at
  the time of contracting while the delivery of the
  item to be sold known as subject matter of salam
  (al Muslam fihi) is deferred. Salam is also known
  as Salaf (lit borrowing)

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Islamic Modes/Instruments - Sale Contracts

• Salam Shariah Legitimacy
• Allh says O ye who believe when you deal with
  each other, in transactions involving future
  obligations in a fixed period time, reduce them
  to writing Al Baqara Verse 282
• Ibn Abbas reported, the Prophet (PBUH) came to
  Medina on Hijrat and found that people were
  selling dates for deferred delivery (salam) over
  a period of one or two years. The Prophet (PBUH)
  said whoever pays for dates on a deferred
  delivery basis (salam) should do so on the basis
  of specified scale and weight Bukhari and
  Muslim

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Islamic Modes/Instruments - Sale Contracts

• Wisdom of allowing Salam
• Farmers, orchard owners, merchants can fulfill
  their working capital and consumption needs
  before the commodity is ready to be sold

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Islamic Modes/Instruments - Sale Contracts

• Salam
• It is an exception to the possession (a rule of
  sale)
• A purchase contract with deferred delivery of
  goods in exchange of advance price fully paid on
  spot (opposite to Murabahah financing)
• Benefits both the seller and purchaser
• Seller (client) receives the price in advance
• Purchaser (Bank) contracts the price which is
  lower than the market price at the time of
  delivery

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Islamic Modes/Instruments - Sale Contracts

• Conditions of Salam
• Salam is a binding contract
• Full price at spot, otherwise selling debt for
  debt (exception upto 3 days)
• Salam capital (price) in principle be in cash,
  however, it can also be fungible commodities
  (wheat etc.), or usufruct Imam Malik
• Debt not recognized as salam capital
• Sale in case of commodities satisfying condition
  of fungibility (Dhawatul Amthal), quantity be
  specified exactly
• Standardized production of companies can also be
  treated as salam commodity
• Product of a particular field or farm cannot be
  sold under Salam

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Islamic Modes/Instruments - Sale Contracts

• Conditions of Salam
• Certain date and place of delivery
• The commodity should remain in the market
  throughout the period of contract Different
  opinions
• Time period for delivery should be sufficient to
  allow use of salam capital conveniently and
  effect prices, preferably be at least 15-30 days
  Different opinions
• Subject matter of salam can be exchanged with
  other goods only after the date of delivery as
  long as this replacement is not the part of
  contract. But market value of exchanged goods
  should not be more than the market value of salam
  goods

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Islamic Modes/Instruments - Sale Contracts

• Conditions of Salam
• If the buyer refuses to take delivery of goods
  (when these meet the specification criteria) he
  should be compelled to take delivery
• If seller fails to deliver due to insolvency he
  should be granted an extension in time of
  delivery
• Salam contract can be cancelled with the consent
  of both parties, and only the original price paid
  is returned
• A security/guarantee or personal surety can be
  obtained as safeguard against risk of default

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Islamic Modes/Instruments - Sale Contracts

• Salam Procedural Alternatives
• The banks face limitations in receiving
  commodities and selling them in the market
• Banks can overcome the limitation by establishing
  a subsidiary to undertake this task
• Banks can adopt Parallel Salam or Third party
  sales to avoid this situation
• Banks can appoint the client its agent to sell
  the commodity. The agency agreement should be
  separate from the salam agreement
• If agent has been able to sell the commodity at a
  price more than the one stipulated in agency
  agreement, he is entitled to get the difference

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Salam Sale Contract 1 June 06
1
2
Salam Price Payment 1 June 06
Client
Delivery of Commodity 20 Dec 06
Purchaser Bank
4
Third Party Promise
3
Pays 20 Dec 06
Promise to Purchase
6
15 June 06
5
Third Party Promise and Payment
Delivery of Commodity 20 Dec 2006
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Islamic Modes/Instruments - Sale Contracts

• Rules of Parallel Salam and Third party promise
• Both the contracts viz. salam and parallel salam
  must be independent of each other, otherwise it
  becomes two sales in one contract
• Parallel salam is allowed only with third
  parties. Therefore the original seller cannot be
  entered into the parallel salam
• If one party breaches its obligation, the bank
  has no right to refuse delivery of goods in
  parallel contract
• The third party giving unilateral promise should
  not pay the price as this is not allowed in
  Shariah

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Islamic Modes/Instruments - Sale Contracts

• Difference Between Salam and Murabaha

Salam Murabahah
Delivery of good is deferred, price is paid at spot Good is delivered at spot, payment of price is deferred
Price has to be paid in full Price can be paid on spot or differed, lump sum or in installments
Salam is not executed in the commodity of particular specifications or the commodity from particular origin Murabaha can be executed in particular commodity.
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Islamic Modes Agricultural Financing

• THANKS