Alhuda CIBE - Presentation on Islamic modes agricultural financing by Muhammad Khaleequzza

Islamic Modes for Agricultural Financing

PRODUCTS – Murabahah and Salam

Lahore 16 – 17 May, 2008 Al – Huda Training Programme

Muhammad Khaleequzzaman

Head Islamic banking DepartmentInt’l Islamic University Islamabad

Islamic Modes – Agricultural Financing

Agricultural production Cycle - Crops

Acquisition of land/Choice of crop

Preparation of land

Crop production operations

Harvesting

Post harvest &Marketing

Entering Contract of cultivation incase of rented land, decision about crop

in view of market demand

STAGE ACTIVITY

Sowing/transplantation, Irrigation, Fertilization,Weeding, Pesticide application

Clearing, Leveling, Plowing, Seed bed preparation,Installation of Irrigation/drainage system

Cutting/ picking,threshing

Cleaning, Grading, Processing, Packing,Storage, Transportation, Sale of produce


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/medication, 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}

Islamic Modes – Agricultural FinancingAreas 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/Istisna}

• 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}


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]

BLANK SLIDE


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’

Theory & Practice of MurabahahPreliminary: Rules applicable for Islamic Sale 1. Subject (good to be sold) must exist at the time of sale2. Subject must be in ownership of seller – Physical or constructive

possession [exception in Salam and Istisna’]3. Subject must be property of value4. Subject should be halal5. Subject must be known and identified6. Sale must be instant and absolute7. Sale must be unconditional8. Delivery of sold item must be certain9. 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

Training Workshop – Islamic Microfinance Preliminary:• Murabahah; historical perspective• Murabahah and Musawamah• Spot and Deferred Murabahah • Deferred Murabahah and Bai Muajjal• Banking Murabahah

Theory & Practice of MurabahahMurabahah – Concept and Historical perspectiveMurabahah 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:• Qura’an: 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...

Process Flow:Promise Stage– Negotiation/Approval of overall limit– MOU/Master Murabahah Facility Agreement– Requisition + Undertaking + Security Deposit (Hamish

jiddiyah)

Bank ClientMOU/Master MFA

Approval of Limit

2

1

Requisition, Undertaking, Sec. Dep. 3

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


Client Bank

Supplier3

2Agency Agreement

Payment Supplier

Agent (3rd Party)

Bank

Supplier2

1Agency Agreement

Payment

Agent (Client)

Receipt of Payment3

Draft of Payment 2 A

Receipt of Payment

Acquisition/Possession Stage– Constructive Possession

• Payment to supplier• Discount of supplier/benefit to client• Title of goods• Transfer of risk and responsibilites


BankAgent

(3rd party)SupplierTitle Goods

Agent(Client)

Risks and Responsibilities

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


Execution of Murabahah

Client Acceptance of Offer

1

2

3

Offer to Purchase

Receipt , Possession Report

Payment of Murabahah Price

Murabahah Terminates

1

Bank Client Murabahah Price

2

Bank

Sec. Deposit/Hamish jiddiyah

Urboun/Securities 4

3


DP Note

Purchase of poultry feed stock

• Murabahah transaction: Rs. 100,000• Murabahah Facility: 90 Days• Payment: Lump sum• Rate of Profit: Six months

KIBOR+2%• Freight: 5% of cost of

goods • Securities: Pledge of feed stock,

post dated cheques


Particulars 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 10%+2% = 12% p.a. 105000 x 12% x 90/365 = 3107

Murabahah Price 105000+3107= 108107

Pricing of Murabahah [Example]:


Theory & Practice of MurabahahIssues in Murabahah:• Oral promise/unilateral – bilateral promise with option• Supplier’s price in the name of customer/without any

name/bank’s 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

Theory & Practice of MurabahahIssues 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

BLANK SLIDE


Islamic Modes/Instruments - Sale Contracts:

Salam: DefinedA 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)


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]


Wisdom of allowing Salam Farmers, orchard owners, merchants can

fulfill their working capital and consumption needs before the commodity is ready to be sold

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

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

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


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

Bank Client

Payment of Salam Price 1-1-2007

Delivery of Goods 30-6-2007

Salam Transaction

Agent

Third Party

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

Client Delivery of Commodity20 Dec 06

PurchaserMFI

Third Party2nd Salam15 June 06

Delivery of Commodity20 Dec 2006

Parallel Salam

Salam Sale Contract 1 June 06 1

2

5

Salam Price Payment 1 June 06

2nd S

alam

Con

trac

t

Paym

ent o

f Pric

e


PurchaserBank

Third Party2nd Salam15 June 06



2

5

3 4


2nd S

alam

Con

trac

t

Paym

ent o

f Pric

e

6

15 J

une

06


PurchaserBank

Third PartyPromise and

Payment


Third PartyPromise


2

53

4

6


Pay

s 20

Dec

06

Prom

ise

to P

urch

ase

15 J

une

06

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


Difference Between Salam and Murabaha

Salam MurabahahDelivery 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.

THANKS


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Alhuda CIBE - Presentation on Islamic modes agricultural financing by Muhammad Khaleequzza