Outlook for Islamic financing of agriculture
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.
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
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
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
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
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
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
Courtesy: The DAWN