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Outlook for Islamic financing of agriculture                        Home
By Dr Ahmad Kaleem

ISLAMIC banks are planning to capture 10 per cent of the total financial market in the next three years. The target may not be met without agriculture financing.

Agriculture credit through formal channels caters to a small number of farmers against the potential rural clients estimated at 5.44 million. There is vast untapped opportunities for Islamic banks which are presently focusing more on consumer and corporate financing.

According to Economic Survey of Pakistan (2005) 65.9 per cent of the total population lives in rural areas and 44.8 per cent of the total labour force is directly employed in agriculture. Overall, the sector represents 23 per cent of country’s GDP.

Lahore School of Economics (LSE) has recently conducted a survey to explore the farmers’ perception on Islamic financing. - Bai Salam.--the contract alternate to traditional interest bearing loans for crop inputs with the output on cash basis.

Bai Salam contract allows seller to deliver the crop at some future date in exchange of an advanced price fully paid at spot. According to Mufti Taqi Usmani, the basic purpose of this sale contract is to meet the needs of the small farmers who need money to grow their crops and to feed their family up to the time of harvest.

The survey shows that 64.5 per cent families belong to categories where one and two members are full-time engaged in agriculture. Farm income on an average represents 65 per cent of total family income . Only 10.1 per cent families are fully dependent upon agriculture income.

Agriculture is highly cash-strapped sector. Cash purchase and sales represent 10.7 per cent and 8.4 per cent of total transactions. Around 80 per cent farmers participate in the credit market. The State Bank report on rural financing (2002) admitted that 70 per cent of the agriculture credit requirements are met by informal credit providers who charge high interest rates ..

LSE survey indicates that 46.5 per cent of the total respondents return their loans after the sale of crop; another 45.5 per cent return their loans whenever they receive money from other sources. About 61.5 per cent of the sample farmers admit that they ‘sometimes’ and 29.4 per cent ‘always’ faced financial problems during the cultivation of crops. Surprisingly, 85.9 per cent of the farmers believe that they can save up to 25 per cent of cost if they purchase inputs on cash.

Farmers inform surveyors that financial institutions restrict them from purchasing seeds, fertilisers and pesticides etc. from authorised dealers who generally sell substandard inputs. Other reasons for low per acre productivity includes unavailability of required water, crop diseases, unavailability of required machinery and transport, old traditional way of cultivation, lack of technical guidance and high cost of diesel and electricity.

Farmers also mention problems faced at the time of crop sales. Of them, 28.48 per cent indicate that they have no option but to sell to the middlemen to adjust their loans. Unavailability of transport to bring crops to nearby markets (20 per cent) is the second major problem. Farmers also complain that they do not find customers who give them cash (13.94 per cent) and they also do not receive money on time (10.91 per cent). Improper way of auction (10.91 per cent) and dishonesty in weight (4.24 per cent) are also some major issues. A majority of the farmers are in debt. Other problems include tedious bank procedures for loans and bad roads

The buyers of the crop are middle-men (43.13 per cent), wholesalers (29.15 per cent), mill owners (18.72 per cent) and the government (9 per cent). Some 72.6 per cent of the farmers said that buyers of their crops ‘sometime’ pay their money late. They also complain that it is difficult to recover money once crop is sold.

A majority of middlemen run licensed shops in the fruit and vegetable markets in all the big cities. Surprising the middlemen are completely disconnected with the commercial banks. Most of the middlemen have considerable funds at their disposal but they perceive obtaining bank loans a hassle.

Pakistani farmers typically borrow money at the beginning of the harvest. They borrow mainly to purchase input (42.48 per cent), to pay for the labour(25.20 per cent), to hire rental machinery (22.56 per cent) and to pay the lease of the agricultural land (9.76 per cent).

Some 47.11 per cent farmers meet their financial needs through borrowing from middlemen, 22.80 per cent from friends and neighbours, 11.55 per cent take advance against crops and 10.33 per cent from banks. Small minority (8.21 per cent) of farmers use their own savings. One farmer comments that ‘bank loan or loan from middleman costs the same after paying the documentation charges and bribe to the bank officials. Around 64.82 per cent farmers can only offer personal guarantee against any formal loan.

The World Bank report (2004) on Pakistan’s agriculture sector indicated that formal loans in Pakistan require collateral and one-third loans are against agriculture land. In contrast, 90 per cent of the informal loans require personal guarantee where the interest rate ranges from 50 per cent to 100 per cent.

Comments of farmers are also collected about the advance sale of crop. Surprisingly, only 35.8 per cent favour the idea of advance selling of crops. Middlemen, who offer such a service, decide the crop price once it comes in the market. Even sometimes the prices of inputs are not negotiated until harvest when it is based on prevailing market rates. In some areas middlemen view cash repayment as a breach of contract terms.

In case of crop failure, 63.13 per cent respondent said that they can repay when they receive money from other sources. Another 35.03 per cent farmers indicated that they can return from next crop. Survey also asks farmers about their level of awareness towards Islamic banking. 48.9 per cent of the total respondents are aware of Islamic banking. They are normally large farmers.

The response of the farmers to the idea of appointing middleman as the bank agent was positive. A majority is either agrees (30.7 per cent) or will decide once the person is appointed (48.4 per cent). Only 20.9 per cent respondents are not in favour of this idea. Farmers also mention some possible problems while dealing with the middlemen such as give less profit, consider own benefit, charge high returns against the facility provided, delay in payments, offer less rate for the crop than the market.

LSE survey concludes that small farmers always face financial problems. They need money to purchase agriculture inputs and rental machinery. Majority of them sell their crop on credit and are highly dependent on middlemen. These small farmers can only provide personal guarantees against any loan.

Proposed models for agriculture financing : Model 1: Bank appoints middleman as its agent or enter in a partnership agreement. Middleman identifies the potential farmers from his area. The loans are only provided against his recommendations and personal guarantee. The bank provides credit direct to the farmer and also develops direct feedback system to monitor crop. Bank may also demand personal guarantees from the farmers. At the time of harvesting middleman is responsible to collect crop from the farmers, sells in the market and returns bank share as per agreement.

Model 2: Bank and mill enter in a partnership agreement under diminishing musharika concept. The mills identifies the potential farmers and recommends them for loan. The bank provides credit direct to the farmers and also develops direct feedback system to monitor the crop. Bank may also demand personal guarantees from the farmers who will also be responsible to transport crop to the mill. Once the crop reaches the mill bank pledges the crop and the mill later purchases bank’s share as per agreed terms and conditions.

Policy Recommendations: Agriculture is considered as the backbone of Pakistan’s economy. The State Bank of Pakistan report on rural finance (2002) indicated that there were 3,183 commercial banks branches in rural areas with a total deposits of Rs159 billion and advances Rs21.50 billion with a lending/deposit ratio of 13.44 per cent. The figures show great scope for Islamic financing of agriculture.

The writer is an associate professor at Lahore School of Economics.

Courtesy: The DAWN;

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