Financing Agricultural Products: The Non-Interest Model.

By | June 28, 2020

The Agricultural sector is one of the poorly financed sector of the economy. Without a fully functional agricultural sector all the gains in the other sectors of the economy will amount to nothing, and food crisis might engulf both the rich and the poor. Majority of the key players in this sector are generally not well educated, so access to finance and the conditions that financial institutions and governmental agencies put forth on the finance facilities are way beyond these peasants or smallholder farmers.

In recent times the government have realized the need to adequately fund the agricultural sector through intervention funds by governmental agencies. In addition, there is also an increasing wave of millennial joining the Agricultural revolution with the aid of smart technology to crowd fund and invest in the Agricultural sector. However, these initiatives have created a buzz in the sector, but has it improved the lives of the real farmers? Yes, the technology savvy millennial might be smiling to the bank but are the real farmers better off? Yes, the government agencies might be showing us huge amount disbursed, but are the real farmers better off?

This short write up is meant to provide a snippets of how Islamic finance can be used to finance agricultural products to better the lives of the farmers, the government agencies, the investors and all those involved in the agricultural sector thus creating a win-win financial solution for all related parties in the value chain.

The basic challenge that farmers have is cash flow – they need cash to cultivate their land and meet their personal and family expenses. Due to the nature of their trade they only get cash at the time of harvest, which is once or twice in a year depending on the nature of their product. To solve this problem, the Prophet of Islam (SAW) legislated the concept of Bay ‘Salam. Ibn ‘Abbas (Allah be pleased with them) reported that when Allah’s Messenger (peace be upon him) came to (Medina) and the people were paying in advance (for the fruits, etc.), he said to them: He who makes an advance payment should not make advance payment except for a specified measure and weight (and for a specified period). (Muslim, No: 3907). This mode of finance allows the farmer to sell their produce in advance thus receiving cash immediately to enable them solve the cash flow problem and ensure that they are not involved in riba (interest) which is a sin in the sight of Allah.

By definition “Bay ‘Salam is a sales contract whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange for an advance price fully paid at spot”. (An introduction to Islamic Finance by Mufti Muhammed Taqi Usmani). Note that this concept violate the core principles of sales in Islam which stipulates that three conditions must be met before a valid sale contract can be executed, and these are:

  • The purchased commodity must be existing.
  • The seller should have acquired the ownership of that commodity.
  • The commodity must be in the physical or constructive possession of the seller

However, Salam contract is an exception to this rule because this is a sale of a special nature as legislated by the Prophet of Islam (SAW) and it comes with its special conditions, however, time and space might not permit us to explain it here in full details. These details and conditions (11 in total) are enumerated in the works of Muhammad Imran Ashraf Usmani (2002) Meean’s Guide to Islamic Banking.

To break this down further we shall illustrate this concept with a practical case study (Note that the figures used are hypothetical): Abdullahi is a farmer having 6 plots of land for the cultivation of cassava tubers located at Kaka village. He needs about 800,000 Naira to cultivate these plots and produce 1 metric tons of cassava tubers in 4 months based on the current climatic condition in the area. The current market value of 1 metric tons of cassava is about 1.4 Million Naira. Below is the breakdown of how this will be financed and executed using the concept of Salam sales contract.

  1. The buyer (investor/ government agency) will purchase the 1 metric tons of cassava from the seller (Abdullahi) and pay the value less than the current market value in this case 1 Million Naira for example.
  2. The seller (Abdullahi) can comfortably cultivate the land with 800,000 Naira and still have some balance of about 200,000 Naira to meet his personal needs.
  3. In the Salam contract, the following must be clearly stated to ensure that it’s a valid forward sales.
    1. The absolute quantity of the produce in this case – 1 metric tons of cassava.
    2. The absolute date of delivery.
    3. The absolute place of delivery
  4. Once the contract matures, the buyer receives the goods and sell at the prevailing market price in this case 1.4 million Naira and he can comfortably make a profit of 400,000 Naira.

In the Salam contract the buyer (investor/ government agencies) and the seller (farmers) find the transactions beneficial to both parties. On the one hand, the seller is able to receive the price in advance while the buyer pays the amount that is usually lower than the market price because the price in Salam contract is always slightly lower than the market price. This answers the big question of how the investor will make profit. The investor makes profit legitimately from the transaction by paying a lower price on the spot and once the goods are received in the future they can sell at a higher price and the difference is where they make their legitimate profit, while the buyer gets instant value (cash) to ensure the goods are produced base on the agreed timelines and they have enough cash to take care of their personal and family obligations.

To ensure that the poor farmers are empowered, our government should jettison the current financial aid model where funds are disbursed with certain fixed interest rate to be paid on the loan advanced to farmers and, in most cases they can’t track if the funds are used for the intended purpose. This model has not worked and it’s open to a lot of corruption due to lack of accountability on all the parties involved.

Implementing the Salam model will bring about equity in the system, transparency and eliminate corruption as funds are not just disbursed to individual but they are used to make purchases of actual products that are tangible and profitable to the farmer and the government. If this model is built into the non-interest financing of agricultural products framework this will have a very positive effect and create an exponential growth in agricultural sectors for the benefits of all parties involved in the value chain.


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