Suggestions on Islamic Agricultural Finance

Looking at the recent guidelines on agriculture finance published by the State Bank of
Pakistan is a good initiation agricultural development. Different modes of financing and its
implication have been suggested. But the main issue that bother financial institutions, is
the risk associated with agricultural sector. Let me be a little more precise, the non-
performance. As stated in the press also regarding the governor’s speech it was stated that
He had also informed about the non-performing loans of agriculture sector that had
declined to 17 per cent in December 2008 from 20 per cent in December 2007 as a result
of improved overall recovery rate of 76 per cent in December 2008 from 71 per cent in
December 2007. Regretting the trend of uneven geographical distribution in agriculture
credit disbursements, the SBP governor urged commercial banks and other stakeholders to
work in close liaison to improve the agricultural credit outreach in the country.”

Islamic Development Bank is also ready to finance up to 65 per cent of the total cost of
projects in textile, agriculture, energy, food, hosiery and garment sectors to foster economic
development in Pakistan.

The concern and the dilemma when we talk about agriculture financing are the credit
recovery and its performance. With the evident experience of the public institution like
Agriculture Development Bank of Pakistan (ADBP) and that of similar nature, we should
device a concrete recovery mechanism in order to make the funds productive.
Consequently the promotion of agricultural economy will turn out to be more perpetual.

If the foreign support is provided with securitize credits, the outcome will insha Allah,
prove to lead towards a prosperous Pakistan. Some suggestions are documented below for
the purpose of idea generation. Although these are very fundamental suggestions but these
can be helpful in devising agricultural schemes. If a workable mechanism is developed it
will assist the proposal effectively. International experiences of models used in Sudan and
Bangladesh (Grameen Bank) may also be useful.

GoP Guarantee

In order to securitize the credits, if GoP guarantee can be formulated, this step will prove
the serious intensions of the government. The recent concern and interest in promoting
agriculture sector will become more sincere. It can be initiated especially when the Islamic
Development Bank has shown its interest in promoting the sector also. As the State has
good control over the rural area with the collaboration of its agents and officials
controlling the region. If the Government of Pakistan is sincere to support the new credit
line in this sector, an agriculturist who is interested in availing any financial facility can
approach the government and ask him to provide a guarantee in his favor to the financial
institutions. In order to assure the government some collaterals and securities can be
offered by the agriculturist to the government so the guarantee is issued against that
security. In case of non-performance and defaults, the state will have the powers for the

Mufti Ehsan Waquar Ahmad ehsanwaquar@yahoo.com Page 1

recourse and exercising the security. The will have the right to adjust the loan aginst the
proceeds. This guarantee will also affect the pricing as the minimum default rate will
subsequently lower the cost of borrowing.

Insurance and Takaful premium will be more viable if such arrangements are made. This
will hopefully reduce the premium also thus again affecting the cost of borrowing to move
on a lower price.

Charity Fund

Islamic bank cannot charge penalties on defaults. Therefore they impose a charity clause.
The details are that defaulters are liable to pay a self imposed charity on occurrence of
defaults. The charity is collected by the banks and disposed of to charitable organizations.
If these funds are utilized to entertain the genuine defaulters who are not evading the
repayments, is another constructive utilization of the funds. Thus the funds will be
reinvested in the economy or more precisely the same sector that is mobilized to support
the agricultural development.

For this purpose, if the charity funds can form a pool like the pool formed under the
takaful arrangement, it will provide assistance to those who encounter bankruptcy because
of force majeure circumstances. The effected individuals can be compensated through the
fund thus repayment of this loan is arranged through that pool. But again the mechanism
and filter so devised should be transparent enough so that the deserving individuals can be
assisted only.

This fund can be expanded not only in agricultural financing but can serve the small and
medium enterprises, cottage industries and microfinance sector.

Disposal of the Commodity under Consideration

Another major issue is the disposal of the commodity purchased through Salam or Istisn’a
mode of finance. As Islamic banks deal is commodity not like conventional banks, this
problem can be resolved if the agricultural sector, financial institution and governmental
institution like PASSCO, TCP etc can work together to form a mechanism. Together the
three will participate in promoting the agriculture sector. A tri party collaboration will
mobilize the economy in a very effective manner. The public entities like PASSCO, TCP
etc can purchase these commodities initially purchased by the Islamic Financial
Institutions. As a result, the state can arrange its future purchase through this channel,
encouraging the banks to participate.

This will not only help in controlling the prices more efficiently, but also in subsidizing the
borrowing cost. Subsequently this will assist the whole economy and the basic necessities
can be provided at modest price to the public. It will also bar activities of black marketers.

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This arrangement can also help the Islamic financial institutions in managing their short
term liquidity issues. Those institutions falling short of funds can enter into a parallel
Salam/ Istisn’a at a discount rate. They will receive the funds immediately and on the other
hand institution with surplus fund will place their liquid assets to generate profit.

Even Salam transaction against machinery and other equipments will be easier and secure.
Farmers can be paid in terms of usufruct of machinery and other equipments and crops
can be booked as the commodity. Similarly usufructs of tractor, other machinery and
equipments can be used as a mode of exchange. Again it will bring multi effect not only in
the agriculture but also in other industries within the economy.

New irrigation system and improvement of those already existing can be devised through
Istisn’a base financing on BOT basis. Global funds for rural development can be utilized to
form such schemes and develop new agricultural lands also.

Sukuk of such projects can be of great interest for the local and foreign investments.
Especially with the Islamic financing mode being the underlying instrument and the strong
religious factor to avoid riba involvement is expected to fly this scheme high.

A very vital objectivity; “equitable justice in the distribution of wealth” the backbone and
the essence of Islamic economy can emerge if theses institution and sector are able to
device any such mechanism.

These are my personal views and not necessarily my institution may have consensus with
them.

Mufti Ehsan W. Ahmad

ehsanwaquar@yahoo.com

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