Islamic Modes for Agricultural
Financing
PRODUCTS – Murabahah and
Salam
Lahore 16 – 17 May, 2008
Al – Huda Training Programme
Muhammad Khaleequzzaman
Head Islamic banking Department
Int’l Islamic University Islamabad
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
Crop production
operations
Clearing, Leveling, Plowing, Seed bed preparation,
Installation of Irrigation/drainage system
Sowing/transplantation, Irrigation, Fertilization,
Weeding, Pesticide application
Harvesting
Cutting/ picking,
threshing
Post harvest &
Marketing
Cleaning, Grading, Processing, Packing,
Storage, Transportation, Sale of produce
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/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 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/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}
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]
Islamic Modes – Agricultural Financing
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 Murabahah
Preliminary: Rules applicable for Islamic Sale
1. Subject (good to be sold) must exist at the time of sale
2. Subject must be in ownership of seller – Physical or constructive
possession [exception in Salam and Istisna’]
3. Subject must be property of value
4. Subject should be halal
5. Subject must be known and identified
6. Sale must be instant and absolute
7. Sale must be unconditional
8. Delivery of sold item must be certain
9. 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 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:
•
Qura’an:
•
Sunnah:
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]
The Prophet (PBUH) purchased a she camel from Abu
Bakr (RAA) for use as transportation from Medinah...
Theory & Practice of Murabahah
Process Flow:
Promise Stage
– Negotiation/Approval of overall limit
– MOU/Master Murabahah Facility Agreement
– Requisition + Undertaking + Security Deposit (Hamish
jiddiyah)
2
Bank
Client
MOU/Master MFA
Approval of Limit
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
Draft of Payment
2A
Agent
(Client)
3
Receipt of Payment
Agent
Client
(3rd Party)
Bank
Bank
Receipt of
Payment
Agency Agreement
2
1
Supplier
Payment
3
2
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
Risks and Responsibilities
Bank
Title
Supplier
Agent
(Client)
Goods
Agent
(3rd party)
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
Theory & Practice of Murabahah
Execution of Murabahah
Urboun/Securities
Offer to Purchase
2
Client
Bank
Acceptance of Offer
3
Receipt , Possession Report
1
Sec. Deposit/Hamish jiddiyah

4
3
DP Note
Payment of Murabahah Price
Murabahah Price
1
Client
Bank
Murabahah Terminates
2
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
KIBOR+2%
• Freight:
5% of cost of goods
• Securities:
Pledge of feed stock,
post dated cheques
Theory & Practice of Murabahah
Pricing of Murabahah [Example]:
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
Theory & Practice of Murabahah
Issues 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 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
Islamic Modes – Agricultural Financing
BLANK SLIDE
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)
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]
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
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
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
Payment of Salam Price 1-1-2007
Bank
Salam
Transaction
Client
Agent
Delivery of Goods 30-6-2007
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
1
Salam Sale Contract 1 June 06
2 Salam Price Payment 1 June 06
Purchaser
Bank
MFI
5
Parallel
Salam
3
Delivery of
Commodity
20 Dec 2006
6
Payment of Price
15 June 06
Delivery of
Commodity
20 Dec 06
2nd Salam Contract
Client
Third Party
2nd Salam
15 June 06
4
1
Salam Sale Contract 1 June 06
2 Salam Price Payment 1 June 06
6
5
Delivery of
Commodity
20 Dec 2006
Third Party
Promise and
Payment
15 June 06
Third Party
Promise
Purchaser
Bank
4
Promise to Purchase
Delivery of
Commodity
20 Dec 06
Pays 20 Dec 06
Client
3
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
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.
Islamic Modes – Agricultural Financing
THANKS