Islamic Modes for Agricultural

Financing

PRODUCTS Murabahah and

Salam
Lahore 16 17 May, 2008
Al Huda Training Programme
Muhammad Khaleequzzaman
Head Islamic banking Department
Intl 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:

Quraan:

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

Requisition, Undertaking, Sec. Dep.

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

Bank
Bank

2A

Agent
(Client)

3
Receipt of Payment

Agent
Client
(3rd Party)
Receipt of
Payment

Agency Agreement
Payment

2
1
3
2

Supplier

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

Client

Bank
Acceptance of Offer

Receipt , Possession Report

Sec. Deposit/Hamish jiddiyah

3
DP Note

Payment of Murabahah Price

Murabahah Price

Client

Bank
Murabahah Terminates

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
Suppliers price in the name of customer/without any
name/banks 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

Salam Sale Contract 1 June 06

2 Salam Price Payment 1 June 06

Purchaser
Bank
MFI

Parallel
Salam

Delivery of
Commodity
20 Dec 2006

Payment of Price
15 June 06

Delivery of
Commodity
20 Dec 06

2nd Salam Contract

Client

Third Party
2nd Salam
15 June 06

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

Promise to Purchase

Delivery of
Commodity
20 Dec 06

Pays 20 Dec 06

Client

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

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