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Agricultural Finance Review Enhancing food security with Islamic microfinance: insights from some recent experiments Mohammed Obaidullah, Article information: To cite this document: Mohammed Obaidullah, (2015) “Enhancing food security with Islamic microfinance: insights from some recent experiments”, Agricultural Finance Review, Vol. 75 Issue: 2, pp.142-168, https:// doi.org/10.1108/AFR-11-2014-0033 Permanent link to this document: https://doi.org/10.1108/AFR-11-2014-0033 Downloaded on: 03 October 2017, At: 00:46 (PT) References: this document contains references to 23 other documents. 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Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) Enhancing food security with Islamic microfinance: insights from some recent experiments Mohammed Obaidullah Islamic Development Bank, Islamic Research and Training Institute, Jeddah, Saudi Arabia and Faculty of Muamalat and Administration, Islamic Sciences University Malaysia, Kuala Lumpur, Malaysia Abstract Purpose – Islamic microfinance institutions (IsMFIs) have used diverse models and tools, as they seek to provide financial and non-financial support to the farming communities. A majortity of IsMFIs focus on provision of micro-credit to farmers alone as a means to enhance food security, following an approach similar to that of the conventional microfinance institutions. Others adopt a “finance-plus” approach and provide support in a multitude of areas other than finance, such as, technology, production, marketing, business development, capacity building, and thus, ultimately steering the project to success. The purpose of this paper is to examine the models and tools of Islamic agricultural finance for the rural poor that display major variations and draw lessons from a policy perspective. Design/methodology/approach – The study undertakes a comprehensive review of the principles, modes and models of Islamic agricultural finance targeted at small-holder farmers. It uses a case study method to review several winning initiatives by IsMFIs across the globe. It highlights the various risks and challenges confronting the projects and how the same are sought to be mitigated. Findings – Islamic agricultural finance for the rural poor involves a range of modes, mechanisms and institutional structures. Credit-based and sharing-based modes work well under specific conditions and there is no one-size-fits-all solution for financing the rural poor. Case studies of successful initiatives reveal that composite models involving the integration of philanthropy-based, not-for-profit as well as for-profit components may provide ideal solutions. Additional factors critical for success include provision of safety nets, involvement of community, non-financial support in a multitude of areas other than finance, such as, technology, procurement, production, marketing, business development and institutional capacity building. Originality/value – The paper addresses a fundamental issue in financing the poor farmers in Muslim societies – whether to opt for a credit-based approach that would ensure greater outreach or to go for a holistic intervention involving financing of the entire value chain. The findings are based on personal interaction of the author with professionals directly involved in the projects. Keywords Food security, Agriculture finance, Islamic microfinance, Livestock finance Paper type Case study 1. Introduction Agriculture plays a major role in enhancing food security and employment opportunities in several countries with large Muslim population, such as, Indonesia, Pakistan and Sudan[1]. It is a significant contributor to the gross domestic products (GDPs) in these countries. In Indonesia, it accounts for over 15 percent of GDP with around 40 percent of the working population employed in this sector[2]. In Pakistan, the corresponding figures are 21 and 45 percent, respectively[3]. In Sudan as well, it is estimated that the sector contributes 35-40 percent of the GDP. Yet, there has been a growing incidence of the farming community in these and other countries seeking alternative sources of livelihood triggering concerns about food security. Key factors Agricultural Finance Review Vol. 75 No. 2, 2015 pp. 142-168 ©Emerald Group Publishing Limited 0002-1466 DOI 10.1108/AFR-11-2014-0033 Received 5 November 2014 Revised 28 December 2014 26 February 2015 Accepted 19 March 2015 The current issue and full text archive of this journal is available on Emerald Insight at: www.emeraldinsight.com/0002-1466.htm 142 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) contributing to this in Indonesia include, among others, declining soil fertility, high input prices, limited capital, human resources with low and limited skills, fluctuating crop prices and above all, continuously declining terms of trade (Mintarti, 2013). In Sudan, the problems are further accentuated due to natural calamities in the form of droughts and civil strife. In Pakistan too, the story is similar. Land access is increasingly becoming a key constraint for many farmers forcing them to seek migration to urban areas in search of alternative sources of livelihood. Studies also show that these countries are characterized by large and increasing number of small farm holdings[4]. An IFPRI (2005) study estimates that Indonesia has about 17.2 million small farms accounting for 88 percent of all farms, while Pakistan has about 3.8 million small farms that constitute 58 percent of all farms. The numbers are also steadily increasing along with a decline in average size of holdings. For example, the average size of holding in Indonesia declined from 1.1 hectare to 0.9 hectare over 1973-1993, the same for Pakistan declined from 5.3 hectares in 1971-1973 to 3.1 hectares in 2000, during which time the number of small farms more than tripled. Sudan presents an interesting contrast with the government owning large tracts of agricultural land[5]. Agricultural holding size varies according to the region and system of production. For example, in central Sudan the government has proactively encouraged mechanized and large-scale farming. The rest of the country has private small-scale farming where the size of holding has continuously declined due to fragmentation because of the operation of the Islamic law of inheritance[6]. Small-scale farmers are the “economically active” poor who witness grave food insecurity and abject poverty. Agriculture is highly dependent on the local conditions: availability of and access to good land, soil, water, climate and market. Further, crops vary widely in terms of duration, perishability, and seasonality. Therefore, provision of microfinance requires different products, diverse and tailor-made approaches. Recent best practices in conventional microfinance advocate “local” interventions based on a value chain approach[7]. A major challenge confronting such microfinance is related to the belief systems of the farmers. Conventional microfinance involves interest-based savings and loans to farmers, which is against the tenets of Islam, the predominant religion in the countries under focus. A study by Karim et al. (2008) undertaken for CGAP based on a survey of the poor in Muslim societies concludes that Islamic microfinance, that is in compliance with the religious tenets “has the potential to combine the Islamic social principle of caring for the less fortunate with microfinance’s power to provide financial access to the poor. Unlocking this potential could be the key to providing financial access to millions of Muslim poor who currently reject microfinance products that do not comply with Islamic law.” Islamic microfinance, therefore, is seen as a solution to the challenge of self-exclusion. Several Islamic microfinance experiments have been undertaken in recent times in predominantly Muslim countries. These poverty alleviation initiatives by the Islamic microfinance institutions (IsMFIs) in the rural areas have sought to counter food insecurity and generate livelihoods by focussing on the agricultural and livestock sectors. IsMFIs have used diverse models and tools of Islamic microfinance, as they seek to provide financial and non-financial support to the farming communities. A majority of IsMFIs focus on provision of micro-credit alone to the farmers, following an approach similar to that of the conventional microfinance institutions. Wadud (2013) for example, argues that policies, which extend microcredit and ensure fair, timely and low-cost delivery of microcredit to marginal and small farmers, could lead to reduction of agricultural farm inefficiency and hence, lead to improvement of performance of 143 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) farms. This could enhance farm output and welfare, help reduce poverty and improve food security. Of course, the IsMFIs that offer microcredit must additionally ensure that the credit product(s) offered by them are based on Shariah-compliant modes, such as, murabaha, bai muajjal and bai salam[8]. Other IsMFIs prefer a more comprehensive and challenging approach. These IsMFIs believe that they must play the role of an anchor and a facilitator in a process of transformation, and in the economic and social empowerment of the farming communities. They prefer to adopt a “project” approach and provide support in a multitude of areas other than finance, such as, technology, production, marketing, business development, capacity building, and thus, ultimately steering the project to success. The aim of this paper is to introduce the reader to the basic principles of Islamic microfinance as applied to the agricultural and rural sector. It seeks to highlight the diversity in Islamic agricultural and rural financing modes and models and to underline their potential reach and richness. The objectives include, among others, a comprehensive micro-level analysis of selected experiments in agricultural microfinance in diverse scenarios. The study uses a case analysis method to present the alternative approaches and composite models and seeks to draw lessons therefrom so that the good practices may be replicated elsewhere and bad practices, if any, may be avoided. In the following section, we undertake a general discussion of the principles and modes of Islamic agricultural finance as undertaken in a majority of case studies. The following three sections present a few successful composite models of intervention. Section 3 presents a case study of economic and social empowerment of farmers by Dompet Dhuafa Republika (DDR), a leading non-government organization in Indonesia. Section 4 presents a case study on an award-winning agri-finance product portfolio by Wasil, a pioneering non-government organization in Pakistan. Section 5 presents case studies of three unique projects of the microfinance unit (IRADA) of the Bank of Khartoum (BoK) in Sudan. Section 6 summarizes the key lessons and concludes. 2. Islamic framework for agricultural finance The Islamic framework for agricultural finance seeks compliance with several fundamental Shariah norms. The two most important and relevant norms are: prohibition of riba and prohibition of excessive gharar[9]. The first essentially rules out any financial or non-financial gains for the lender offering credit-based products. The second rules out excessive risk, uncertainty, undue complexity and conditionality in the financial products. Islamic finance literature identifies several modes for provision of agricultural finance that conform to the above. While some of these modes are sale or lease-based and create debt obligations on the part of the farmer, others are sharingbased and create partnerships between the farmer and the financial institution. 2.1 Bai muajjal-murabaha (credit-cost plus sale) Bai muajjal is a sale where payment of price is deferred to a future date. Often it includes features of a murabaha, which implies a sale on a cost-plus basis. As a microcredit product, bai muajjal-murabaha is the most popular product among IsMFI accounting for over two-third of the total Islamic microfinance portfolio (El-Zoghbi and Tarazi, 2013). The mechanism may be described as follows. Farmer A needs to purchase farm equipment or livestock X. He approaches the IsMFI. Now, the IsMFI buys X from the vendor/supplier at price P. Next, IsMFI sells X to A at a marked-up price, say P+M, where Mis the agreed profit or mark-up taken by IsMFI. The payment 144 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) of price P+M is deferred to a future date and is made in full or in parts. This Islamic credit product comes very close to the conventional interest-based credit, which perhaps explains its popularity with the IsMFIs. Yet, there is a clear line of distinction between the two. The quantum of debt created under the former is the price of the underlying commodity that is fixed at the time of contracting and that remains at this level even if the maturity of the product is extended subsequently. In conventional credit products, however, the quantum of debt increases, compounded at the interest rate as maturity increases (as in case of loan restructuring). Bai-Istijrar is a variant of the bai-murabaha and takes place when the buyer purchases different quantities of a given commodity from a single seller over a period of time. Istijrar permits greater flexibility in the matter of fixation of price, which may now be deferred to a future date (and not at the time of contracting as in bai-murabaha) and may indeed be based on a normal price or average price in a volatile market. This mode, thus, offers a natural way to reduce price risk. Though ideal for rural finance where farmers often buy their raw materials and inputs in small quantities from the same IsMFI over extended periods, istijrar has not been used extensively to date[10]. Several studies (Obaidullah, 2008b) and (Obaidullah and Shirazi, 2014) have documented the case of the Rural Development Scheme (RDS) of the Islami Bank Bangladesh that replicates the Grameen model[11] but uses bai muajjal (replacing Grameen interest-bearing loan) as its primary mode of meeting the financing needs of the farmers and the rural poor. The case studies highlight some possible issues of Shariah non-compliance. For instance, in bai muajjal finance, one would expect the amount of financing to vary, given that the wide range of commodities being financed, have different prices. RDS on the contrary, provides a uniform financing amount, similar to the basic loan of Grameen. This involves practical impossibilities, since many commodities are not perfectly divisible and be the subject of exchange in fractional units[12]. Further, bai muajjal may not be suitable for financing all kinds of income-generating farming activities, such as, growing vegetables, fishing and other agri-based activities. While bai muajjal can be used to finance the purchase of saplings, fertilizer, fishing nets and so on, in practice, the farmers would need funding not just for the physical asset(s) involved, but also to finance the working capital requirement. Bai muajjal, thus, provides a partial solution only. Another issue with RDS use of bai muajjal arises out of the Shariah requirement of settlement of each of the two sale transactions sequentially in a single bai muajjal. In a scenario where farmers need to buy their raw materials and inputs in small quantities repeatedly, meeting the above Shariah requirement in bai muajjal may involve substantial non-financial costs. As mentioned above, the use of bai istijrar in such cases is possible and desirable too, as it can reduce such transaction costs. However, its potential remains largely untapped. 2.2 Ijara (leasing) Ijara in simple terms implies leasing or hiring of a physical asset. It is also a popular and flexible product in which the IsMFI owns a physical asset (e.g. land, farm equipment) and leases the same to the farmer. The farmer in need of the asset receives the benefits associated with its ownership against payment of predetermined rentals. In ijara, the risks associated with ownership of the asset remain with the IsMFI and the asset reverts to the IsMFI at the end of the ijara period. Ijara is, therefore, similar to conventional operational lease (though there are finer points of distinction including use of penalties and interest in some scenarios). Ijara works well in a scenario where the 145 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) IsMFI is organized as a farmers’ cooperative or an organization that primarily serves the farmers. Pure financial intermediaries prefer a lease ending with ownership of the asset by the lessee-farmer. In such an arrangement, the cash flows are structured in a way that cover the cost of the asset and provide for a fair return on the same to the IsMFI. The IsMFI after recovering its cost and fair return may simply donate the asset or sell the asset at a nominal price to the farmer. 2.3 Bai-salam (deferred delivery) Bai-salam is essentially a forward agreement where delivery occurs at a future date in exchange for spot payment of price. Unlike earlier mechanisms of bai muajjal and ijara, salam or salaf was originally designed as a pre-cultivation financing mechanismfor small farmers. Under a salam agreement, a farmer in need of short-term funds sells its output in advance to the IsMFI on a deferred delivery basis. It receives full price of the farm output on the spot that serves its pre-cultivation financing needs. At a pre-agreed future date, it delivers the output to the IsMFI. The IsMFI then sells the output in the market at the prevailing price. Since the spot price that the IsMFI pays is pegged lower than the expected future price, the transaction should result in a profit for the IsMFI. Thus, under salam the farmers would receive the price of their produce in advance at the beginning of agricultural season against an obligation to deliver a defined quantity of the produce to the buyer after a definite time period in future (after harvest). The sale price received in advance is available to the farmer as a means of financing all farming related needs. Another advantage is that the farmers do not have to sell their produce at a time when the market has an oversupply due to harvest, thus depressing the prices and bringing down the realized income of farmers. While the mechanism provides for much needed financing, it is subject to abuse by unscrupulous intermediaries and traders who seek to take advantage of low bargaining power of the poverty-ridden farmers and execute salam at unrealistically low prices. To counter this, mutuality-based models of microfinance have been suggested. Farmers’ cooperative organizations can dramatically enhance the bargaining power of farmers and replace intermediaries. In a salam-based framework, these cooperatives would provide funds in the form of advance price and would take delivery of the produce after harvest as above. The cooperative would also create appropriate warehousing facilities for storage of the produce and market the same in a manner that avoids depressed prices resulting in increased income for the members. The Jeddah-based Islamic Development Bankmay be credited with pioneering this model successfully. The model involves creating cooperatives (mudarabas) of farmers, and placing funds with them for salam financing to member farmers as well as providing other non-financial services relating to warehousing, processing, packaging and marketing services in a few of its member countries, such as, Guinea and Palestine[13]. Another problem with classical salam for the financier arises out of its exposure to price risk or market risk. A financier who is not an astute player in the market for the concerned commodity and does not fully understand the economics of pricing in this market may be confronted with adverse prices and consequent losses when it seeks to sell the produce upon delivery by the farmer(s). This problem may be taken care of in several ways. First, a back-to-back salam under which the IsMFI enters into a parallel salam with a market vendor (say, a miller) and locks a forward price mitigates their price risk. Once the farmer delivers the output to the IsMFI, the same in turn is delivered to the vendor. The difference between the two advance prices is pre-determined profit for the IsMFI. Second, a variant of bai salamcalled value-based salamis specifically designed to mitigate price risk. This may be explained with the following example. 146 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) In a classical salam, the quantity of object of sale (agricultural produce) and the price per unit of the object of sale are pre-determined at the time of contracting. If Q amount of paddy is sold on forward basis at price P on salam basis, then the financier (buyer) would pay the value of transaction PQ to the farmer (seller) at the time of contracting (before commencement of farming). After a defined and known time period (harvest time), the farmer would deliver Q amount of paddy to the financier. The financier in turn, would find a way to dispose of Q amount of paddy in the market at the prevailing market price P*. If market price increases during the financing period, P* would be higher than P. In other words, P*Q would be higher than PQ and the financier would have positive profits (P*Q−PQ). If however (and this is quite likely given the abundant supply of produce during harvesting season) the prevailing market price is depressed and P* is lower than P, the financier would end up with losses. The value of P*Q−PQ would be negative. This market risk or price risk is mitigated in case of a value-based salam. In the latter type of salam, the MFI would pay an amount (say V) to the farmers’ cooperative at the time of the contract against an obligation of the farmer to repay in physical quantities of its produce whose value at the time of delivery at a future date (after harvest) is pre-determined (say V*). In other words, the farmer would deliver V*/P1 quantity of paddy to the MFI if the future price at the time of delivery is P1 and V*/P2 quantity of paddy if the future price is P2 and V*/P* quantity of paddy if the future price is P*. This settlement value (V*) may indeed be pegged higher than the original value (V) received in advance by the farmer resulting in a known profit (V*−V) to the financier. While this form of contracting is not well known, Obaidullah and Saleem (2011) presents a case study involving its application in Sri Lanka. The case study documents the case of Muslim Aid (MA) Sri Lanka seeking to take care of the safety needs of the poor farmers, to build a sustainable source of funds for them as a cooperative organization and to free them from exploitation by trader-middlemen by intervention through the market mechanism. MA also sought to create a win-win situation for the trader-middlemen by forming a partnership with them. MA used a multi-stage model for provision of finance and other inputs to the farmers. The first stage involves a creative variant of the classical bai-salam or “deferred delivery” transaction. Under this mechanism, a farmer was provided funds in advance against a forward sale of his produce at the time of harvest. The funds were used by the farmer to finance purchase of the necessary inputs to start paddy cultivation. Unlike bank financings, no collateral was required from the farmer. Instead, a farmer needed to obtain a set of recommendations from the local mosque and community leaders who acted as guarantors. The second stage began at harvest time once the agricultural produce was delivered to MA. It involved a partnership between MA and local miller(s) to take possession of the harvested paddy from the farmers, process it and sell the final product at the market with the profit being shared between MA and the miller(s) on the basis of a mudharabah partnership. It was expected that the profit share of MA would cover the administration cost of the financing. In order to ensure that the over-all model was a not-for-profit one and that it was also sustainable one, any surplus of profit share over administrative cost was to be used to create a Revolving Fund for the farmers (see Figure 1). Farmers enjoying incremental income were also expected to make zakah contributions to this Fund and therefore, adding to its size and ability to provide financing to greater numbers. This was the third stage of the model[14]. The modes discussed above, involve credit and may be used by an IsMFI as Shariah-compliant modes of extending micro-credit to farmers. A major problem 147 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) associated with such modes relates to the possibility of willful default by clients. Unlike conventional microfinance where defaults may result in additional interest payments and/or rescheduling of loan, and where prepayment may result in rebates, Islamic modes do not admit the possibility of any payment in excess of the original amount of debt. Islamic scholars generally permit the IsMFI to impose a penalty on the defaulting client to act as a deterrent against willful default, but such penalty must be donated to a charity. It cannot be treated as an earned income for the IsMFI as this would tantamount to riba. Such income is indeed reported in the financial statement of IsMFIs as “non-halal” or impermissible income that must be donated. 2.4 Mudaraba-musharaka (trustee partnership-joint venture) IsMFI may also consider various partnership based modes or equity-based modes for financing poor farmers. Two classical modes commonly discussed in this context are mudaraba and musharaka. We also discuss a novel concept of declining musharaka leading to complete ownership of asset or project by the farmer. These equity-based products are unique to Islamic rural finance and in some sense, account for its superiority over its conventional counterpart on grounds of ethics and efficiency. Arguably, because of their uniqueness, they are also less commonplace. A mudaraba also known as trustee-partnership is a mode of finance through which the IsMFI provides capital finance for a specific agri-venture initiated by the farmer. The IsMFI, called rabb-al-mal is the owner of the capital and the farmer, called mudarib, is responsible for the management of the agri-venture. Profit is shared according to a pre-agreed ratio. Losses if any are entirely absorbed by the capital provider – the IsMFI. Mudaraba may be of two types – restricted or unrestricted. In a restricted mudaraba (mudaraba al-muqayyada), the IsMFI may specify a particular business in which investments may be undertaken. Mudaraba may also be an unrestricted one (mudaraba al-mutlaqa); in which case the mudarib may invest the capital provided in any venture (s)he deems fit. A musharaka or a joint venture involves a partnership in which both the IsMFI and the farmer contribute to entrepreneurship and capital. It is an agreement whereby the farmer and the IsMFI agree to combine financial resources to undertake a venture, and agree to manage the venture according to the terms of the agreement. Profits are shared between the IsMFI and the farmer in the pre-agreed ratio. Losses are shared strictly in proportion to their respective capital contributions. A variant of musharaka that has traditionally been used in Muslim societies for agriculture is muzara’a or output sharing. This mode allows the owners of inputs for Salam (Value-Based) Mudaraba Money to farmers as price in advance Repayment in paddy plus zakah Process paddy and sell in market at profit Recover admin cost + profit + capital 5 Months 5 Months Profit Figure 1. Overview of MA model 148 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) agriculture, e.g. land and labor to come together and undertake cultivation. The output post-harvest is shared between the land owner and the laborer (landless farmer) as per a pre-agreed ratio. Another variant known as musaqa is a contract between the owner of an orchard (of fruits or vegetables) and a farmer who can irrigate and look after the orchard. The output of the orchard is shared between the parties as per a pre-agreed ratio. An interesting project (supported by the Islamic Development Bank) to help poor olive farmers in Palestine involves use of a composite model. The IsMFI is involved in each step of the olive value chain. First, it facilitates a muzara’a agreement between the landowners and the poor farmers. It provides salam financing for olive seeds and fertilizers. The olive harvest collected by IsMFI is sold to olive oil mills for a profit. The uniqueness of this model as compared to conventional model is as follows. In the event of loss due to crop failure: the landowners would lose potential income under profit-sharing; the farmers would have to pay back (cash or in kind) to the IsMFI no more than the advance payment and the IsMFI would lose potential profit from sale of olives to oil mills. Under the conventional model, however, a different set of outcomes would be in place in case of crop failure. The farmers would have to pay rentals due to landowners; principal loan due to MFI; and interest due to MFI. In short the poor farmers would have to bear the entire downside risk with agriculture. Another variant of musharaka called diminishing musharaka has great potential for the IsMFI as a financing product. While a classical musharaka aims to involve the IsMFI as a permanent partner in the venture, in a declining musharaka, the IsMFI’s share in the equity is diminished each year through partial return of capital. The IsMFI receives periodic profits based on its reduced equity share that remains invested during the period. The share of the farmer in the capital steadily increases over time, ultimately resulting in complete ownership of the venture. Agency problems with partnership-based modes in Islamic finance are cited as the key reason behind preference of mainstream Islamic financial institutions (IsFIs) for debt-based products. The problems – for example, when the mudarib or the trusteemanager may act in a manner that is not in the best interests of the capital-providers – become particularly acute in informal and rural settings. A few other problems that are usually cited with partnership-based modes as compared to sale and lease based modes are as follows: One, partnership-based mechanisms require long-term involvement by the microfinance institutions in the form of technical/ business assistance, which raises the cost of implementation. Two, the uncertainty about profits is a major drawback of such modes. Although microfinance programs have information on local market behavior, weekly profits fluctuate. Fluctuating profits make it extremely difficult for institutions to predict their cash flows. Farmers can make the job doubly difficult by not keeping accurate accounts. Three, the partnership-based modes are difficult to understand for IsMFI officers and borrowers alike. Even in the hypothetical situation that profits were known, the borrower has to repay a different amount each period (and the officer has to collect a different amount each period). This lack of simplicity relative to equal repayment installments is a source of confusion for borrower-farmers and IsMFI officials. Unlike profit-sharing mechanisms, bai muajjal does not require the farmer to maintain written records that are often unavailable at the rural enterprise level or if available, the farmer may be unwilling to share them. While IsMFIs may use some or all of the above for-profit modes in the interest of sustainability, their mission driven approach of helping the rural poor requires provision of a mix of financial and non-financial services that include handholding and 149 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) other forms of support to farmers. The overall objective is benevolence-driven and often strictly not-for-profit. Indeed, Islamic economics and finance provide a range of benevolence-driven, philanthropy-based and not-for-profit mechanisms as well, whose importance can be hardly overemphasized, especially when seeking to address the financing needs of the poor farmers. 2.5 Qard al-hasan (interest-free loan) Qard hasan literally means a beautiful loan. It is a loan granted by the lender without expectation of any return on the principal. Islam provides very strong incentives for lenders to meet the financial requirements of the needy by providing loans without expecting any gain in return from them. Any such return expected or demanded by the lender is forbidden riba. It is pertinent to note several things here. First, the lender is permitted to recover the actual cost it incurs in the process from the beneficiary or the borrower. However, the amount charged to borrower must not be more than the actual cost of operation. Thus charging the borrower based on notional or estimated cost of operation is ruled out. Two, Islam exhorts a borrower to be generous when (s)he repays. (S)he is allowed and indeed, encouraged to return more than (s)he originally borrowed from the lender. The excess is viewed as a gift (heba) from the borrower and is permissible as long as it is not demanded (stipulated in the contract) by the lender. A Muslim is also encouraged to avoid debt. (S)he should strive to get out of debt if (s)he is already trapped in it. (S)he must make all efforts to repay the loan as early as possible. At the same time, Islam encourages a lender to give extension in time or waive part of the loan, should the borrower be forced to default. It completely rules out any penalty for default that is unintentional. However, in case of willful default or delinquencies, a penalty may be imposed as a deterrent. Such penalty, once collected, must be donated to charity and cannot form part of the income of the lender. At an institutional level, one finds that this mode forms the basis of over 6,000 Qard al-Hasan Funds (QHFs) dotted across Iran, which provide microfinance primarily to the rural poor[15]. The QHFs raise funds using the qard al-hasan mode from their depositors; and lend onwards also using the same mode. Another interesting application of this mode on the lending side only (funds are raised through charity) is the Akhuwat model in Pakistan[16]. 2.6 Sadaqa, zakat and waqf (charities and endowments) The broad term for charity and philanthropy in Islam is sadaqa. Sadaqa is in the nature of free donation without any strings attached. When compulsorily mandated on an eligible Muslim, sadaqa is called zakat. When sadaqa results in flow of benefits that are expected to be stable and permanent (such as, through endowment of a physical property), it is called sadaqa jariya or waqf. Zakat is an institution of philanthropy mandated by faith. It may also be seen as a compulsory levy on every believing and practicing high-net-worth Muslim. From a macroeconomic perspective, zakat is a source of recurring annual flow of funds. Since Islamic law restricts the allocation of zakat funds to eligible beneciaries alone, that primarily include the poor and the needy, zakat is potentially a major tool of poverty alleviation. It is more in the nature of a safety net to take care of the basic necessities of life of poor farmers who cannot afford them. Additionally, zakat funds can be used in a variety of ways for the farmers; for skill enhancement, provision of start-up capital, or pay off the debt of the over-indebted farmers as long as the beneficiaries suffer from abject poverty. 150 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) Waqf, which essentially implies the irreversible endowment of an asset of value (e.g. real estate, cash) by a donor with a stipulation that the returns generated through investment of the asset or the benefits flowing out of the asset are used for specified purposes. Thus waqf, by definition, provides for a sustainable source of funds/ benefits that may be targeted at the poor farmers. To sum up, Islamic finance provides a fairly broad range of modes and mechanisms that may be used for provision of financial and non-financial services and support to the poor farmers. Often some or all of these charity-based, not-for-profit and for-profit mechanisms are combined in models to provide holistic solutions to the problems of the poor farmers, alleviate their poverty and help them enhance food security. In the next three sections, we discuss some composite models of intervention that are recent and deemed highly successful by observers. 3. Farmers’ empowerment program (Indonesia) DDR is a pioneer in using Islamic philanthropic funds, such as, zakat, sadaqa and cash waqf for alleviating poverty. The program for economic and social empowerment of farmers by this leading non-government organization[17] in Indonesia seeks to provide a solution to the multiple problems of limited land, declining soil fertility, high input prices, limited capital, low and limited farming skills, unremunerative and fluctuating crop prices. It has embarked on an organic farmers’ empowerment program called Pemberdayaan Pertanian Sehat (P3S) that adopts a holistic approach involving adjustment of cropping patterns and change in farmers’ attitude and preferences from conventional farming to a semi-organic cultivation system. The intervention involves gradual and continuous assistance, guidance and introduction to production facilities that are safe, locally made and affordable, to biotech and low-chemicals system through integrated and environment-friendly farming. The semi-organic cultivation system reduces farmers’ permanent dependency on chemical agricultural inputs that are expensive. With the user-friendly green agricultural technology, farmers can reduce production costs while obtaining higher prices for the organic produce. The organic farmers empowerment program (P3S) involves provision of farmland on ijara (lease) and of capital for semi-organic farming with a view to bringing about significant increase in farmers’ earnings. The empowerment process also involves strengthening of farmers’ capacity as human resources and helping them get organized as formal communities, called combined farmers groups (gapoktan). The intervention ends when the combined farmers groups have developed the capacity to manage the formal organization independently, putting in place partnerships with other stakeholders to support the organization’s existence, and improved their bargaining position in the market. Farmers’ eligibility for P3S program is based on several criteria, e.g. income and ownership, business potential and the farmers’ potential as human resources. The main target group are poor farmers meeting the following criteria. The farmers’ family head earns ⩽ two USD per day in rural areas, or ⩽three USD per day in sub urban areas. The other criteria relate to condition of their house and ownership of assets. Approval from local neighborhood based on the defined criteria is needed to confirm a poor family’s eligibility for the program. The business potential criteria include: the development potential, which reflects the ability to expand the business in scale and scope, related to the raw materials availability, production capacity, market potency and employment rate; the potential to create derivative businesses that allows more employments and economic benefits for other beneficiaries; and the potential for local 151 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) resources utilization. Besides the above, a farmer must be of minimum productive age of 18 years or is married, with maximum age of 60 years; should have the vision for developing business; should be able to work; and should not be enlisted as participant of any other similar program. 3.1 Components of the program[18] The empowerment program involves several stages. Stage 1 involves promoting awareness or recognition of potential and the environment followed by building comprehension that organization in the center-stage of this process must be started with the community’s initiative through continuous strengthening of the organization. The programs then aims to prepare a cadre of local farmers who would take over the task of mentoring after the program ends; to provide technical support, associated to the technical aspects of the production process, which includes the introduction and implementation of organic farming technology and semi-organic farming, adaptation of technology, development of pre-and post-harvest processes as well as access to information. It seeks to assist the farmers in fulfilling their needs, both individually and in groups, in a sustainable livelihood system. The overall objective is to maintain a balance in the interests of all the stakeholders by enhancing the bargaining power of farmers through their own cooperation-based institution. The process of forming farmers’ organization involves the following stages. First, individual farmers in groups of eight to ten form small groups. Next, several groups are organized into a secondary group called a combined farmers’ group called gapoktan[19]. Finally, several gapoktans are combined to form the farmers’ cooperative. Since a major problem for farmers is the lack of land ownership, one of the components of the P3S program is the provision of leased land to farmers. Once farmers groups are formed, the next stage is the leasing of land to each farmer at an average land area of 25,000 m2 for each farmer or 2.5 hectares (six acres) for each group. Farmers get lease land for one year with the rental fee of Rp 4,000.000 (USD 150) per hectare per annum. In addition to the land lease package, farmers also receive a package in the form of processing costs of land, direct costs of labor for one growing season. Farmers are expected to use the organic agricultural inputs (saprotan) and working capital funds of the enterprise. Labor fees are directly paid for the overall processes of land production and harvest. Assistance is also provided in the form of fertilizer, compost, plant pesticides, seeds, etc. The program through research has developed its own organic agricultural input (saprotan) in the form of bio pesticide that is local-based, affordable and environment friendly. A major component of the empowerment program is institutional capacity-building. Assistance for the strengthening of the institutional groups of farmers and farmer groups (gapoktan) involves the following. Enhancing the capacity of farmers is done through various forms of training in semi-organic agriculture as also in organizational and financial management of farm groups and gapoktan administrators, establishment of the gapoktan forum, as well as periodic monitoring and linking up to other stakeholders and the market. For instance, during the process of cultivation of rice, the tutoring process, both regular and irregular meetings, is done through visits to the homes of the farmers. Tutoring is done through regular meetings of the Group once a week. The process of transfer of appropriate technology and organic rice cultivation is delivered through group meetings. An example of the move towards self-sufficiency is a consensus made among farmers that each farmer must save up to 40 percent of their harvest, which would initially be used to pay land lease for the following year. 152 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) 3.2 Zakat-funded programs The organic farmers empowerment program (P3S) along with other economic empowerment programs of DDR is funded with zakat. The funds dedicated to such programs average about IDR 6.3 billion per year over the five-year period (2008-2012) that hovers around 10 percent of total zakat resources available (see Table I). The low dedication is attributable to apparent Shariah objections by some scholars who emphasize on utilization of zakat for consumption alone in the short term. In the face of a growing realization, however, that an emphasis on short-term may lead to a dependency syndrome among the poor, and that the long term need of the poor is economic and social self-reliance, DDR seeks to enhance the utilization of zakat for community empowerment programs. Among the major economic programs of DDR are: the masyarakat mandiri (self-reliant communities), pertanian sehat (health/ organic farming), kampoeng ternak nusantara (livestock development), Islamic microfinance (for-profit) in addition to capacity building initiatives under Indonesia Magnificence Zakat. The economic empowerment programs follow a similar model that involves interest-free loan financing to groups from a pool created out of zakat funds. The key distinguishing factor of this model is the phased building of self-reliant communities and the creation of a community organization that would continue to provide financing to the members. The program has a clear termination and exit strategy. It withdraws from the region and the program ends as soon as the community cadres are ready to take part in maintaining program sustainability – financial and institutional. It ensures that a community-based organization is a legal entity with adequate capacity to sustain cooperation with all stakeholders. From a Shariah perspective, this ensures that the “tamleek” condition of zakat is complied with, since the poor beneficiaries ultimately become the owners of the local organization in a collective sense with transfer of assets from the program to the local organization. Thus, the fact that they are borrowers in the first instance does not appear to vitiate the “tamleek” requirement[20]. 4. Credit and lease-based finance (Pakistan) According to a survey by a group of researchers from Lahore University of Agriculture [21], there are about 5.1 million farms in Pakistan. Of this, 93 percent are small and marginal accounting for 60 percent of the total cultivated area. They also found that about 70 percent of farmers participate in the credit market; a majority from intermediaries charging exorbitant interest rates. Further, the farmers also believe that they can save up to 25 percent in costs if they purchase inputs on cash. In addition, given that farmers usually return the money after the sale of the crop, the study argues that banks should participate in agricultural sector using bai salam as the mode of No. Field program Program Funds (Rp billion) Beneficiaries 1. Organic farming 15 4.6 2,611 2. Livestock 9 6 997 3. Fisheries 52 11.1 6,175 4. For-profit microfinance 6 4.3 2,186 5. Research, in house and public training 150 5.6 5,164 Total 232 31.7 17,133 Table I. Five-year details on economic empowerment programs by DDR 153 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) finance. A similar reasoning seems to underlie the design and development of salam as an agri-finance product by Wasil Foundation, a leading Islamic microfinance provider in Pakistan. Wasil Foundation, formerly known as Centre for Women Co-Operative Development (CWCD), is a not-for-profit company established in 1992. The aim of the organization is to economically empower poor communities and assist them in developing their businesses through micro credit and enterprise development programs. In 2009, Wasil Foundation (formerly CWCD) extended its operations from conventional microfinance to Islamic microfinance. Eventually, it discontinued conventional microfinance in 2010, thus becoming a purely Islamic microfinance organization. The pioneering efforts of Wasil Foundation in meeting the financing needs of different strata among the urban and rural poor has resulted in a diverse range of products in its portfolio (see Table II). Thus, Wasil has three products specifically targeted at the farming community. It believes that farmers in Pakistan are traditionally skilled but lack capital. Its first product based on bai salam is targeted at small farmers with up to five acre land holding, who need money to grow their crops and to feed their families up to the time of harvest. Under the salam agreement, Wasil makes payment of agreed price in advance to the farmer against commitment to deliver agreed quantity of produce upon harvest. It involves lower cost as compared to other alternatives and finance is provided against a collateral in the shape of guarantee from community members or a charge on available assets with the farmer, e.g. livestock. Wasil’s second product seeks to address the issue of lack of land ownership among farmers through leasing. Wasil takes agriculture land on ijara from the owners of the land in bulk and sub-leases the same to farmers for agreed period in exchange of pre-determined monthly lease rentals. In case of fruits/vegetable/flower farms the lease rental is paid in cash. In the case of wheat and rice, the lease rental is paid in kind in the form of crops. Wasil’s third product combines the concepts of ijara and salam and bases the whole return on the principles of salam, which requires settlement of debt in terms of the crops or produce. Under this agreement called Master salam, the farmer gets land on rental plus cash as working capital to cover related costs and agrees to deliver a given quantity of the crop to Wasil. A part of the repayment in terms of crop is towards rentals on ijara while another part relates to salam. After the first cycle of finance, there are two subsequent cycles of financing that are based on salam alone. After the two additional salam cycles, the contract ends. 4.1 Risk factors and their mitigation The main challenge concerning the salam transaction is the identification of the quality of the crop and the determination of the price at which it must be procured. The Government of Pakistan issues a support price for wheat at which the Food Mode Target beneficiary Zakat Destitute unable to work Qard al-hasan Poorest of the poor with ability to work Murabaha Micro level traders street hawker Small shopkeepers Salam Small farmers up to 5 acre land holding Ijara Farmers without land holding (rental land) Diminishing Musharaka Micro entrepreneur in need of assets Master Salam (Ijara + Salam) Developed by CWCD farmers in need of land plus money for cultivation Table II. Islamic finance products by Wasil 154 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) Department of Government of Pakistan procures it. However, when Wasil Foundation approached these departments for the sale of crop, they refused due to the restriction levied upon them by the Government of Pakistan whereby only a farmer may sell to these departments. Thus, the only other options were the sale to the flourmills or to the open market. Furthermore, unlike the support price at which the Government purchases the crop, the flourmills and the open market rates are determined by certain market factors including the quantity of national produce. In order to determine the price, Wasil Foundation takes the data of the sale price in a specific area over the last three years. This gives a rough estimate of what the price is likely to be for the crop that is to be grown. Wasil Foundation then offers a float rate at which the purchase price is negotiated with the farmer/client. This negotiation takes place at the village level with groups of farmers who are likely to sell the crop to Wasil Foundation. At the end of this negotiation, Wasil foundation determines a final price at which it procures the crop. At times, this price may vary from area to area based on the cost of production, the expected yield, the sale price of the area in the last years and the amount of risk that the organization has to face. In June of 2010, Wasil Foundation launched its first rice salam transaction. Unlike wheat, the market rate of rice crop is entirely dependent on the quality of the crop wherein the seed of the crop is of major importance. In the case of wheat, the seed being planted does not directly affect the price, as the output crop is the same. In case of rice crops, these are categorized in accordance to the seed that is being planted by the farmer. Thus, the challenge of the quality of the crop and the proper identification of the seed is of vital importance while conducting a salam transaction on rice. For this, Wasil Foundation trained its procurement and sales department, through the agriculture department of Government of Punjab, Pakistan, on the types of rice and the identification techniques of rice. Unlike wheat, there is no support price by the Government for rice, which makes the estimation of the purchase price more complex for rice. The options open for Wasil Foundation are again, as in the case of wheat, the selling of the crop to the open market or the rice mills in the area. However, unlike wheat, when rice is harvested, it contains a high moisture content due to which the total weight of rice is increased by approximately 15-20 percent. This moisture further induces a chance for the crop to be damaged if it is not dried up in time. These issues increase the risk of holding rice at a warehouse for collection and sales purposes. Thus, unlike wheat, which may be stored for up to three months by Wasil Foundation, rice is to be sold within a maximum of one-month period due to the unavailability of the proper infrastructure to store rice. This challenge still exists while conducting a rice transaction of salam. The crux of the Master-salam product is the repayment in the form of crop rather than cash. This makes enormous sense, given that the client/farmer is not rich in cash during his crop cycles, which makes it difficult for the farmer to make the monthly repayment in cash. However, the farmer/client is rich in crop at the time of harvesting. Therefore, the product is focused on the principles of salam wherein the crop is delivered as a repayment for cash inputs, plus for the extra input of land in the form of ijara. 5. Composite partnerships with farmers (Sudan) A model that has been experimented in Sudan in the recent past adopts a composite finance-plus approach to support the farming communities.While there are elements of credit-based financing, the overall models are rooted in partnership. The underlying rationale for this approach seems to be the pivotal role that the IsFIs see for themselves 155 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) in addressing various problems of the poor farmers and in enhancing food security of the region. While agriculture in Sudan faces problems similar to those in Indonesia and Pakistan, the challenges here are even greater arising out of adverse weather conditions, large tracts of drought-affected land and civil strife leading to a faltering economy riddled with unemployment. Islamic microfinance in Sudan, however, has a lot to offer in terms of its uniqueness and high success rate. The microfinance program of BoK, known as IRADA, is experimenting with new and innovative models of intervention to make inroads on chronic social problems, such as, poverty and unemployment. As part of the Sudanese economic system, it operates as a Shariah compliant bank. At the same time, it uses participatory modes within a model that is rooted in cooperation to create and share wealth in the agriculture sector[22]. BoK was established in 2002 while its microfinance program (IRADA) was established in 2009 with the support and assistance from the Islamic Development Bank. The department was given the mandate to implement the SDG 200 million Al-Aman fund for microfinance. The fund was formed by a strategic partnership between the Diwan Zakah (apex body of zakat management in Sudan) and 32 Sudanese commercial banks. IRADA was set up with a vision “to alleviate poverty and hunger by realizing the potential of the poor through development of limited resources and affordable financial facilities,” and a mission “to increase the numbers of poor people involved in entrepreneurial activities through Islamic finance and expanding income generating activities, creating sustainable livelihood and employment.” Its programs and activities are influenced by its strategic approach theme, which states, “Today the poor are our clients, but tomorrow they will be our business partners.” Since inception, IRADA identified and focused on “economic empowerment through group finance and partnership.” 5.1 Innovative use of zakat In perhaps the first documented example of utilization of zakat for gharimeen (indebted) in an organized manner, globally speaking, a security portfolio was created through a partnership between the Diwan Zakah (apex body for zakat management in Sudan) and commercial banks. The portfolio has a capital of 200 million pounds with 25 percent contributed by the former and the balance by the banks. The portfolio provides an insurance to the program against genuine defaults by clients at the second level. At the first level, the default is covered by individual personal guarantor(s) brought in by the client. The portfolio covers all productive sectors (commercial, agricultural and vocational) across Sudan. 5.2 Business development services IRADA has carefully developed a network of providers of business development services on its payroll to provide a range of additional services to its clients. In many ways, these officers are key to the overall success of the program with their ability to source and procure the assets needed for the income-generating microenterprises and their role in monitoring the clients. In fact, each client is assigned a business development officer who is responsible for ensuring that the relevant asset is delivered to client, that the supplier is paid, and that the client makes timely repayment to the bank. The business development officers are also entrusted with the task of advising the clients on how their business can be more profitable. They also use their network in order to facilitate mutual exchange among their clients. The provision of business development service is adequately incentivized. 156 AFR 75,2 Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) 5.3 Abu-Halima Greenhouses Project The Abu-Halima Greenhouses Project of IRADA, designed in 2011, uses a composite model of intervention that combines several “smart” factors and is designed to address several critical social issues including lack of food security, unemployment and poverty. It aims to open new economic opportunities for young university graduates with formal education in agriculture. The project in its current phase, targets economic empowerment of 125 educated unemployed graduates and their families. The project involves setting up 25 productive units of greenhouses with annual capacity production of 1,200 tons of off-season vegetables using latest technology in the industry and professional expertise using the partnership-based mode. The business plan of the project is rooted in the economic peculiarities of the local market for vegetables, which witnesses a major spurt in the vegetable prices because of adverse weather conditions. The greenhouses would enable the micro-entrepreneurs to grow high-value vegetables all through the year, while smoothening the supply of vegetables in the Khartoum market. The greenhouses can now grow vegetables that usually witness many-fold price rise during summer and other high-value vegetables during winter, thus, reducing price volatility. The underlying model for the project is presented in Figure 2. The model (restricted mudaraba partnership). Unlike the regular micro-credit products, or even the commercial mudaraba products, the partnership between the bank and the micro-entrepreneurs extends well beyond that of a creditor and debtor or that of a rabb-al-maal (fund provider) and mudarib (fund manager). The bank assumes Min. of Finance IRADA – BoK Abu Halima Min. of Social Affairs Graduates Min. of Agriculture Tech Consultant Sana Hypermarket 1 2 3 5 7 6 8 9 10 4 Notes: Arrows denote specific activities as follows: (1) financial partnership between Ministry of Finance and BoK; (2) nomination of agriculture graduates for the project by Ministry of Social Affairs; (3) Mudaraba agreement between IRADA (BoK) and the micro entrepreneurs (agriculture graduates); (4) setting up of Abu Halima greenhouses; (5) technical consultancy to micro entrepreneurs; (6) technical consultancy to greenhouse establishment and operation; (7) provision of fertilizers and other services by Ministry of Agriculture; (8) sale of vegetables output to Sana Hypermarket and others; (9) sharing of profits (40 percent for five years and 100 percent after that) by micro entrepreneurs; and (10) sharing of profits (60 percent) by IRADA-BoK for five years Figure 2. The Abu Halima Project 157 Islamic microfinance Downloaded by SAUDI DIGITAL LIBRARY (SDL) At 00:46 03 October 2017 (PT) responsibility for provision of financial as well as a range of non-financial services to the micro-entrepreneur in the form of technical, marketing and business development services. The latter involves direct investment in creation of assets for supply of electricity, water as well as for vegetable cooling, storage and other services. A beneficiary of this project must come from low-income strata of the Sudanese society and the income of the household should not exceed two times the minimum wage of USD 207 per month according to the law of Central Bank of Sudan. The beneficiaries are organized into jointly liable groups of households (headed by graduates, preferably in agriculture) in the form of a cooperative society registered according to the Sudanese Cooperative Law. These groups enter into the restricted mudaraba partnership contract with BoK. The micro-entrepreneurs receive the required technical training from experts, managerial and marketing support from the bank. They are eventually organized into a co-operative, which allows them to benefit from common facilities while retaining their right to do business activities. Other stakeholders and partners in the project include: Ministry of Finance, which has made a social contribution of 6.5 percent of capital; the State Ministry of Agriculture, which helps get fertilizers and assists in technical capacity building; the Ministry of Social Affairs, which nominates the beneficiaries through its Graduate Fund; and Sanaa food hypermart and home center – a major supermarket chain – which has committed to off-take the vegetables. A technical Turkish firm, specializing in the technical aspects of greenhouse projects is a significant contributor to the success of the project. Financing method. The financing product is structured using the mudaraba mode with profit and loss features. Losses would be absorbed by the bank while profits would be shared in the ratio of 40 percent for the micro-entrepreneur and 60 percent for the bank. Profit distribution would take place twice in a year. The “restricted” mudaraba involves total financing to the tune of SDG 15 million (USD 4.50 million), which accounts for about 6 percent of the total portfo

Agricultural Finance Review
Enhancing food security with Islamic microfinance: insights from some recent
experiments
Mohammed Obaidullah,
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some recent experiments”, Agricultural Finance Review, Vol. 75 Issue: 2, pp.142-168, https://
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Enhancing food security with
Islamic microfinance: insights
from some recent experiments
Mohammed Obaidullah
Islamic Development Bank, Islamic Research and Training Institute,
Jeddah, Saudi Arabia and
Faculty of Muamalat and Administration,
Islamic Sciences University Malaysia, Kuala Lumpur, Malaysia
Abstract
Purpose – Islamic microfinance institutions (IsMFIs) have used diverse models and tools, as they seek
to provide financial and non-financial support to the farming communities. A majortity of IsMFIs
focus on provision of micro-credit to farmers alone as a means to enhance food security, following
an approach similar to that of the conventional microfinance institutions. Others adopt a “finance-plus”
approach and provide support in a multitude of areas other than finance, such as, technology, production,
marketing, business development, capacity building, and thus, ultimately steering the project to success.
The purpose of this paper is to examine the models and tools of Islamic agricultural finance for the rural
poor that display major variations and draw lessons from a policy perspective.
Design/methodology/approach – The study undertakes a comprehensive review of the principles,
modes and models of Islamic agricultural finance targeted at small-holder farmers. It uses a case study
method to review several winning initiatives by IsMFIs across the globe. It highlights the various risks
and challenges confronting the projects and how the same are sought to be mitigated.
Findings – Islamic agricultural finance for the rural poor involves a range of modes, mechanisms
and institutional structures. Credit-based and sharing-based modes work well under specific conditions
and there is no one-size-fits-all solution for financing the rural poor. Case studies of successful
initiatives reveal that composite models involving the integration of philanthropy-based, not-for-profit
as well as for-profit components may provide ideal solutions. Additional factors critical for success
include provision of safety nets, involvement of community, non-financial support in a multitude
of areas other than finance, such as, technology, procurement, production, marketing, business
development and institutional capacity building.
Originality/value – The paper addresses a fundamental issue in financing the poor farmers
in Muslim societies – whether to opt for a credit-based approach that would ensure greater outreach
or to go for a holistic intervention involving financing of the entire value chain. The findings are based
on personal interaction of the author with professionals directly involved in the projects.
Keywords Food security, Agriculture finance, Islamic microfinance, Livestock finance
Paper type Case study
1. Introduction
Agriculture plays a major role in enhancing food security and employment
opportunities in several countries with large Muslim population, such as, Indonesia,
Pakistan and Sudan[1]. It is a significant contributor to the gross domestic products
(GDPs) in these countries. In Indonesia, it accounts for over 15 percent of GDP with
around 40 percent of the working population employed in this sector[2]. In Pakistan, the
corresponding figures are 21 and 45 percent, respectively[3]. In Sudan as well, it is
estimated that the sector contributes 35-40 percent of the GDP. Yet, there has been a
growing incidence of the farming community in these and other countries seeking
alternative sources of livelihood triggering concerns about food security. Key factors
Agricultural Finance Review
Vol. 75 No. 2, 2015
pp. 142-168
©Emerald Group Publishing Limited
0002-1466
DOI 10.1108/AFR-11-2014-0033
Received 5 November 2014
Revised 28 December 2014
26 February 2015
Accepted 19 March 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/0002-1466.htm
142
AFR
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contributing to this in Indonesia include, among others, declining soil fertility, high
input prices, limited capital, human resources with low and limited skills, fluctuating
crop prices and above all, continuously declining terms of trade (Mintarti, 2013). In
Sudan, the problems are further accentuated due to natural calamities in the form of
droughts and civil strife. In Pakistan too, the story is similar. Land access is increasingly
becoming a key constraint for many farmers forcing them to seek migration to urban
areas in search of alternative sources of livelihood. Studies also show that these
countries are characterized by large and increasing number of small farm holdings[4].
An IFPRI (2005) study estimates that Indonesia has about 17.2 million small farms
accounting for 88 percent of all farms, while Pakistan has about 3.8 million small farms
that constitute 58 percent of all farms. The numbers are also steadily increasing along with
a decline in average size of holdings. For example, the average size of holding in Indonesia
declined from 1.1 hectare to 0.9 hectare over 1973-1993, the same for Pakistan declined
from 5.3 hectares in 1971-1973 to 3.1 hectares in 2000, during which time the number of
small farms more than tripled. Sudan presents an interesting contrast with the
government owning large tracts of agricultural land[5]. Agricultural holding size varies
according to the region and system of production. For example, in central Sudan the
government has proactively encouraged mechanized and large-scale farming. The rest of
the country has private small-scale farming where the size of holding has continuously
declined due to fragmentation because of the operation of the Islamic law of inheritance[6].
Small-scale farmers are the “economically active” poor who witness grave food
insecurity and abject poverty. Agriculture is highly dependent on the local conditions:
availability of and access to good land, soil, water, climate and market. Further, crops
vary widely in terms of duration, perishability, and seasonality. Therefore, provision of
microfinance requires different products, diverse and tailor-made approaches. Recent
best practices in conventional microfinance advocate “local” interventions based on a
value chain approach[7].
A major challenge confronting such microfinance is related to the belief systems of
the farmers. Conventional microfinance involves interest-based savings and loans to
farmers, which is against the tenets of Islam, the predominant religion in the countries
under focus. A study by Karim et al. (2008) undertaken for CGAP based on a survey of
the poor in Muslim societies concludes that Islamic microfinance, that is in compliance
with the religious tenets “has the potential to combine the Islamic social principle of
caring for the less fortunate with microfinance’s power to provide financial access to
the poor. Unlocking this potential could be the key to providing financial access to
millions of Muslim poor who currently reject microfinance products that do not comply
with Islamic law.” Islamic microfinance, therefore, is seen as a solution to the challenge
of self-exclusion.
Several Islamic microfinance experiments have been undertaken in recent times in
predominantly Muslim countries. These poverty alleviation initiatives by the Islamic
microfinance institutions (IsMFIs) in the rural areas have sought to counter food
insecurity and generate livelihoods by focussing on the agricultural and livestock
sectors. IsMFIs have used diverse models and tools of Islamic microfinance, as they
seek to provide financial and non-financial support to the farming communities.
A majority of IsMFIs focus on provision of micro-credit alone to the farmers, following
an approach similar to that of the conventional microfinance institutions. Wadud (2013)
for example, argues that policies, which extend microcredit and ensure fair, timely and
low-cost delivery of microcredit to marginal and small farmers, could lead to reduction
of agricultural farm inefficiency and hence, lead to improvement of performance of
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farms. This could enhance farm output and welfare, help reduce poverty and improve
food security. Of course, the IsMFIs that offer microcredit must additionally ensure that
the credit product(s) offered by them are based on Shariah-compliant modes, such
as, murabaha, bai muajjal and bai salam[8]. Other IsMFIs prefer a more comprehensive
and challenging approach. These IsMFIs believe that they must play the role of an
anchor and a facilitator in a process of transformation, and in the economic and social
empowerment of the farming communities. They prefer to adopt a “project” approach
and provide support in a multitude of areas other than finance, such as, technology,
production, marketing, business development, capacity building, and thus, ultimately
steering the project to success.
The aim of this paper is to introduce the reader to the basic principles of Islamic
microfinance as applied to the agricultural and rural sector. It seeks to highlight the
diversity in Islamic agricultural and rural financing modes and models and to underline
their potential reach and richness. The objectives include, among others, a comprehensive
micro-level analysis of selected experiments in agricultural microfinance in diverse
scenarios. The study uses a case analysis method to present the alternative approaches
and composite models and seeks to draw lessons therefrom so that the good practices may
be replicated elsewhere and bad practices, if any, may be avoided.
In the following section, we undertake a general discussion of the principles
and modes of Islamic agricultural finance as undertaken in a majority of case studies.
The following three sections present a few successful composite models of intervention.
Section 3 presents a case study of economic and social empowerment of farmers by
Dompet Dhuafa Republika (DDR), a leading non-government organization in Indonesia.
Section 4 presents a case study on an award-winning agri-finance product portfolio
by Wasil, a pioneering non-government organization in Pakistan. Section 5 presents
case studies of three unique projects of the microfinance unit (IRADA) of the Bank of
Khartoum (BoK) in Sudan. Section 6 summarizes the key lessons and concludes.
2. Islamic framework for agricultural finance
The Islamic framework for agricultural finance seeks compliance with several
fundamental Shariah norms. The two most important and relevant norms are:
prohibition of riba and prohibition of excessive gharar[9]. The first essentially rules out
any financial or non-financial gains for the lender offering credit-based products. The
second rules out excessive risk, uncertainty, undue complexity and conditionality in the
financial products. Islamic finance literature identifies several modes for provision of
agricultural finance that conform to the above. While some of these modes are sale or
lease-based and create debt obligations on the part of the farmer, others are sharingbased
and create partnerships between the farmer and the financial institution.
2.1 Bai muajjal-murabaha (credit-cost plus sale)
Bai muajjal is a sale where payment of price is deferred to a future date. Often it
includes features of a murabaha, which implies a sale on a cost-plus basis. As a microcredit
product, bai muajjal-murabaha is the most popular product among IsMFI
accounting for over two-third of the total Islamic microfinance portfolio (El-Zoghbi and
Tarazi, 2013). The mechanism may be described as follows. Farmer A needs to
purchase farm equipment or livestock X. He approaches the IsMFI. Now, the IsMFI
buys X from the vendor/supplier at price P. Next, IsMFI sells X to A at a marked-up
price, say P+M, where Mis the agreed profit or mark-up taken by IsMFI. The payment
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of price P+M is deferred to a future date and is made in full or in parts. This Islamic
credit product comes very close to the conventional interest-based credit, which
perhaps explains its popularity with the IsMFIs. Yet, there is a clear line of distinction
between the two. The quantum of debt created under the former is the price of the
underlying commodity that is fixed at the time of contracting and that remains at this
level even if the maturity of the product is extended subsequently. In conventional
credit products, however, the quantum of debt increases, compounded at the interest
rate as maturity increases (as in case of loan restructuring).
Bai-Istijrar is a variant of the bai-murabaha and takes place when the buyer
purchases different quantities of a given commodity from a single seller over a period
of time. Istijrar permits greater flexibility in the matter of fixation of price, which may
now be deferred to a future date (and not at the time of contracting as in bai-murabaha)
and may indeed be based on a normal price or average price in a volatile market.
This mode, thus, offers a natural way to reduce price risk. Though ideal for rural finance
where farmers often buy their raw materials and inputs in small quantities from the same
IsMFI over extended periods, istijrar has not been used extensively to date[10].
Several studies (Obaidullah, 2008b) and (Obaidullah and Shirazi, 2014) have
documented the case of the Rural Development Scheme (RDS) of the Islami Bank
Bangladesh that replicates the Grameen model[11] but uses bai muajjal (replacing
Grameen interest-bearing loan) as its primary mode of meeting the financing needs
of the farmers and the rural poor. The case studies highlight some possible issues of
Shariah non-compliance. For instance, in bai muajjal finance, one would expect the
amount of financing to vary, given that the wide range of commodities being financed,
have different prices. RDS on the contrary, provides a uniform financing amount,
similar to the basic loan of Grameen. This involves practical impossibilities, since
many commodities are not perfectly divisible and be the subject of exchange in
fractional units[12]. Further, bai muajjal may not be suitable for financing all kinds of
income-generating farming activities, such as, growing vegetables, fishing and other
agri-based activities. While bai muajjal can be used to finance the purchase of saplings,
fertilizer, fishing nets and so on, in practice, the farmers would need funding not just
for the physical asset(s) involved, but also to finance the working capital requirement.
Bai muajjal, thus, provides a partial solution only.
Another issue with RDS use of bai muajjal arises out of the Shariah requirement of
settlement of each of the two sale transactions sequentially in a single bai muajjal.
In a scenario where farmers need to buy their raw materials and inputs in small
quantities repeatedly, meeting the above Shariah requirement in bai muajjal may
involve substantial non-financial costs. As mentioned above, the use of bai istijrar in
such cases is possible and desirable too, as it can reduce such transaction costs.
However, its potential remains largely untapped.
2.2 Ijara (leasing)
Ijara in simple terms implies leasing or hiring of a physical asset. It is also a popular
and flexible product in which the IsMFI owns a physical asset (e.g. land, farm
equipment) and leases the same to the farmer. The farmer in need of the asset receives
the benefits associated with its ownership against payment of predetermined rentals.
In ijara, the risks associated with ownership of the asset remain with the IsMFI and the
asset reverts to the IsMFI at the end of the ijara period. Ijara is, therefore, similar to
conventional operational lease (though there are finer points of distinction including
use of penalties and interest in some scenarios). Ijara works well in a scenario where the
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IsMFI is organized as a farmers’ cooperative or an organization that primarily serves
the farmers. Pure financial intermediaries prefer a lease ending with ownership of the
asset by the lessee-farmer. In such an arrangement, the cash flows are structured in
a way that cover the cost of the asset and provide for a fair return on the same to the
IsMFI. The IsMFI after recovering its cost and fair return may simply donate the asset
or sell the asset at a nominal price to the farmer.
2.3 Bai-salam (deferred delivery)
Bai-salam is essentially a forward agreement where delivery occurs at a future date in
exchange for spot payment of price. Unlike earlier mechanisms of bai muajjal and ijara,
salam or salaf was originally designed as a pre-cultivation financing mechanismfor small
farmers. Under a salam agreement, a farmer in need of short-term funds sells its output in
advance to the IsMFI on a deferred delivery basis. It receives full price of the farm output
on the spot that serves its pre-cultivation financing needs. At a pre-agreed future date, it
delivers the output to the IsMFI. The IsMFI then sells the output in the market at the
prevailing price. Since the spot price that the IsMFI pays is pegged lower than the
expected future price, the transaction should result in a profit for the IsMFI.
Thus, under salam the farmers would receive the price of their produce in advance at
the beginning of agricultural season against an obligation to deliver a defined quantity
of the produce to the buyer after a definite time period in future (after harvest). The sale
price received in advance is available to the farmer as a means of financing all farming
related needs. Another advantage is that the farmers do not have to sell their produce
at a time when the market has an oversupply due to harvest, thus depressing the prices
and bringing down the realized income of farmers. While the mechanism provides for
much needed financing, it is subject to abuse by unscrupulous intermediaries and traders
who seek to take advantage of low bargaining power of the poverty-ridden farmers and
execute salam at unrealistically low prices. To counter this, mutuality-based models of
microfinance have been suggested. Farmers’ cooperative organizations can dramatically
enhance the bargaining power of farmers and replace intermediaries. In a salam-based
framework, these cooperatives would provide funds in the form of advance price and
would take delivery of the produce after harvest as above. The cooperative would also
create appropriate warehousing facilities for storage of the produce and market the same
in a manner that avoids depressed prices resulting in increased income for the members.
The Jeddah-based Islamic Development Bankmay be credited with pioneering this model
successfully. The model involves creating cooperatives (mudarabas) of farmers, and
placing funds with them for salam financing to member farmers as well as providing
other non-financial services relating to warehousing, processing, packaging and
marketing services in a few of its member countries, such as, Guinea and Palestine[13].
Another problem with classical salam for the financier arises out of its exposure to
price risk or market risk. A financier who is not an astute player in the market for the
concerned commodity and does not fully understand the economics of pricing in this
market may be confronted with adverse prices and consequent losses when it seeks to
sell the produce upon delivery by the farmer(s). This problem may be taken care of in
several ways. First, a back-to-back salam under which the IsMFI enters into a parallel
salam with a market vendor (say, a miller) and locks a forward price mitigates their price
risk. Once the farmer delivers the output to the IsMFI, the same in turn is delivered to
the vendor. The difference between the two advance prices is pre-determined profit for
the IsMFI. Second, a variant of bai salamcalled value-based salamis specifically designed
to mitigate price risk. This may be explained with the following example.
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In a classical salam, the quantity of object of sale (agricultural produce) and the price
per unit of the object of sale are pre-determined at the time of contracting. If Q amount
of paddy is sold on forward basis at price P on salam basis, then the financier (buyer)
would pay the value of transaction PQ to the farmer (seller) at the time of contracting
(before commencement of farming). After a defined and known time period (harvest
time), the farmer would deliver Q amount of paddy to the financier. The financier in
turn, would find a way to dispose of Q amount of paddy in the market at the prevailing
market price P*. If market price increases during the financing period, P* would be
higher than P. In other words, P*Q would be higher than PQ and the financier would
have positive profits (P*Q−PQ). If however (and this is quite likely given the abundant
supply of produce during harvesting season) the prevailing market price is depressed
and P* is lower than P, the financier would end up with losses. The value of P*Q−PQ
would be negative. This market risk or price risk is mitigated in case of a value-based
salam. In the latter type of salam, the MFI would pay an amount (say V) to the farmers’
cooperative at the time of the contract against an obligation of the farmer to repay in
physical quantities of its produce whose value at the time of delivery at a future
date (after harvest) is pre-determined (say V*). In other words, the farmer would deliver
V*/P1 quantity of paddy to the MFI if the future price at the time of delivery is P1 and
V*/P2 quantity of paddy if the future price is P2 and V*/P* quantity of paddy if the
future price is P*. This settlement value (V*) may indeed be pegged higher than the
original value (V) received in advance by the farmer resulting in a known profit (V*−V)
to the financier. While this form of contracting is not well known, Obaidullah and
Saleem (2011) presents a case study involving its application in Sri Lanka. The case
study documents the case of Muslim Aid (MA) Sri Lanka seeking to take care of the
safety needs of the poor farmers, to build a sustainable source of funds for them as
a cooperative organization and to free them from exploitation by trader-middlemen by
intervention through the market mechanism. MA also sought to create a win-win
situation for the trader-middlemen by forming a partnership with them.
MA used a multi-stage model for provision of finance and other inputs to the
farmers. The first stage involves a creative variant of the classical bai-salam or
“deferred delivery” transaction. Under this mechanism, a farmer was provided funds
in advance against a forward sale of his produce at the time of harvest. The funds were
used by the farmer to finance purchase of the necessary inputs to start paddy
cultivation. Unlike bank financings, no collateral was required from the farmer. Instead,
a farmer needed to obtain a set of recommendations from the local mosque and
community leaders who acted as guarantors. The second stage began at harvest time
once the agricultural produce was delivered to MA. It involved a partnership between
MA and local miller(s) to take possession of the harvested paddy from the farmers,
process it and sell the final product at the market with the profit being shared between
MA and the miller(s) on the basis of a mudharabah partnership. It was expected
that the profit share of MA would cover the administration cost of the financing.
In order to ensure that the over-all model was a not-for-profit one and that it was also
sustainable one, any surplus of profit share over administrative cost was to be used to
create a Revolving Fund for the farmers (see Figure 1). Farmers enjoying incremental
income were also expected to make zakah contributions to this Fund and therefore,
adding to its size and ability to provide financing to greater numbers. This was the
third stage of the model[14].
The modes discussed above, involve credit and may be used by an IsMFI as
Shariah-compliant modes of extending micro-credit to farmers. A major problem
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associated with such modes relates to the possibility of willful default by clients. Unlike
conventional microfinance where defaults may result in additional interest payments
and/or rescheduling of loan, and where prepayment may result in rebates, Islamic
modes do not admit the possibility of any payment in excess of the original amount of
debt. Islamic scholars generally permit the IsMFI to impose a penalty on the defaulting
client to act as a deterrent against willful default, but such penalty must be donated to
a charity. It cannot be treated as an earned income for the IsMFI as this would
tantamount to riba. Such income is indeed reported in the financial statement of IsMFIs
as “non-halal” or impermissible income that must be donated.
2.4 Mudaraba-musharaka (trustee partnership-joint venture)
IsMFI may also consider various partnership based modes or equity-based modes for
financing poor farmers. Two classical modes commonly discussed in this context are
mudaraba and musharaka. We also discuss a novel concept of declining musharaka
leading to complete ownership of asset or project by the farmer. These equity-based
products are unique to Islamic rural finance and in some sense, account for its superiority
over its conventional counterpart on grounds of ethics and efficiency. Arguably, because
of their uniqueness, they are also less commonplace.
A mudaraba also known as trustee-partnership is a mode of finance through which
the IsMFI provides capital finance for a specific agri-venture initiated by the farmer.
The IsMFI, called rabb-al-mal is the owner of the capital and the farmer, called mudarib,
is responsible for the management of the agri-venture. Profit is shared according to
a pre-agreed ratio. Losses if any are entirely absorbed by the capital provider – the
IsMFI. Mudaraba may be of two types – restricted or unrestricted. In a restricted
mudaraba (mudaraba al-muqayyada), the IsMFI may specify a particular business
in which investments may be undertaken. Mudaraba may also be an unrestricted one
(mudaraba al-mutlaqa); in which case the mudarib may invest the capital provided in
any venture (s)he deems fit.
A musharaka or a joint venture involves a partnership in which both the IsMFI and
the farmer contribute to entrepreneurship and capital. It is an agreement whereby the
farmer and the IsMFI agree to combine financial resources to undertake a venture, and
agree to manage the venture according to the terms of the agreement. Profits are shared
between the IsMFI and the farmer in the pre-agreed ratio. Losses are shared strictly in
proportion to their respective capital contributions.
A variant of musharaka that has traditionally been used in Muslim societies for
agriculture is muzara’a or output sharing. This mode allows the owners of inputs for
Salam (Value-Based) Mudaraba
Money to
farmers as
price in
advance
Repayment in
paddy plus
zakah
Process
paddy and sell
in market at
profit
Recover
admin cost +
profit +
capital
5 Months 5 Months
Profit Figure 1.
Overview of
MA model
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agriculture, e.g. land and labor to come together and undertake cultivation. The
output post-harvest is shared between the land owner and the laborer (landless farmer)
as per a pre-agreed ratio. Another variant known as musaqa is a contract between the
owner of an orchard (of fruits or vegetables) and a farmer who can irrigate and look
after the orchard. The output of the orchard is shared between the parties as per a
pre-agreed ratio.
An interesting project (supported by the Islamic Development Bank) to help poor
olive farmers in Palestine involves use of a composite model. The IsMFI is involved in
each step of the olive value chain. First, it facilitates a muzara’a agreement between
the landowners and the poor farmers. It provides salam financing for olive seeds
and fertilizers. The olive harvest collected by IsMFI is sold to olive oil mills for a profit.
The uniqueness of this model as compared to conventional model is as follows. In the
event of loss due to crop failure: the landowners would lose potential income under
profit-sharing; the farmers would have to pay back (cash or in kind) to the IsMFI
no more than the advance payment and the IsMFI would lose potential profit from sale
of olives to oil mills. Under the conventional model, however, a different set of outcomes
would be in place in case of crop failure. The farmers would have to pay rentals due
to landowners; principal loan due to MFI; and interest due to MFI. In short the poor
farmers would have to bear the entire downside risk with agriculture.
Another variant of musharaka called diminishing musharaka has great potential
for the IsMFI as a financing product. While a classical musharaka aims to involve
the IsMFI as a permanent partner in the venture, in a declining musharaka, the IsMFI’s
share in the equity is diminished each year through partial return of capital. The IsMFI
receives periodic profits based on its reduced equity share that remains invested during
the period. The share of the farmer in the capital steadily increases over time, ultimately
resulting in complete ownership of the venture.
Agency problems with partnership-based modes in Islamic finance are cited as the
key reason behind preference of mainstream Islamic financial institutions (IsFIs) for
debt-based products. The problems – for example, when the mudarib or the trusteemanager
may act in a manner that is not in the best interests of the capital-providers –
become particularly acute in informal and rural settings. A few other problems that are
usually cited with partnership-based modes as compared to sale and lease based modes
are as follows: One, partnership-based mechanisms require long-term involvement by
the microfinance institutions in the form of technical/ business assistance, which raises
the cost of implementation. Two, the uncertainty about profits is a major drawback of
such modes. Although microfinance programs have information on local market
behavior, weekly profits fluctuate. Fluctuating profits make it extremely difficult for
institutions to predict their cash flows. Farmers can make the job doubly difficult by
not keeping accurate accounts. Three, the partnership-based modes are difficult to
understand for IsMFI officers and borrowers alike. Even in the hypothetical situation
that profits were known, the borrower has to repay a different amount each period (and
the officer has to collect a different amount each period). This lack of simplicity relative
to equal repayment installments is a source of confusion for borrower-farmers and
IsMFI officials. Unlike profit-sharing mechanisms, bai muajjal does not require the
farmer to maintain written records that are often unavailable at the rural enterprise
level or if available, the farmer may be unwilling to share them.
While IsMFIs may use some or all of the above for-profit modes in the interest of
sustainability, their mission driven approach of helping the rural poor requires
provision of a mix of financial and non-financial services that include handholding and
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other forms of support to farmers. The overall objective is benevolence-driven and
often strictly not-for-profit. Indeed, Islamic economics and finance provide a range of
benevolence-driven, philanthropy-based and not-for-profit mechanisms as well, whose
importance can be hardly overemphasized, especially when seeking to address the
financing needs of the poor farmers.
2.5 Qard al-hasan (interest-free loan)
Qard hasan literally means a beautiful loan. It is a loan granted by the lender without
expectation of any return on the principal. Islam provides very strong incentives for
lenders to meet the financial requirements of the needy by providing loans without
expecting any gain in return from them. Any such return expected or demanded by the
lender is forbidden riba. It is pertinent to note several things here. First, the lender is
permitted to recover the actual cost it incurs in the process from the beneficiary or the
borrower. However, the amount charged to borrower must not be more than the actual
cost of operation. Thus charging the borrower based on notional or estimated cost of
operation is ruled out. Two, Islam exhorts a borrower to be generous when (s)he repays.
(S)he is allowed and indeed, encouraged to return more than (s)he originally borrowed
from the lender. The excess is viewed as a gift (heba) from the borrower and is
permissible as long as it is not demanded (stipulated in the contract) by the lender.
A Muslim is also encouraged to avoid debt. (S)he should strive to get out of debt if (s)he
is already trapped in it. (S)he must make all efforts to repay the loan as early as
possible. At the same time, Islam encourages a lender to give extension in time or waive
part of the loan, should the borrower be forced to default. It completely rules out any
penalty for default that is unintentional. However, in case of willful default or
delinquencies, a penalty may be imposed as a deterrent. Such penalty, once collected,
must be donated to charity and cannot form part of the income of the lender. At an
institutional level, one finds that this mode forms the basis of over 6,000 Qard al-Hasan
Funds (QHFs) dotted across Iran, which provide microfinance primarily to the rural
poor[15]. The QHFs raise funds using the qard al-hasan mode from their depositors;
and lend onwards also using the same mode. Another interesting application of this
mode on the lending side only (funds are raised through charity) is the Akhuwat model
in Pakistan[16].
2.6 Sadaqa, zakat and waqf (charities and endowments)
The broad term for charity and philanthropy in Islam is sadaqa. Sadaqa is in the nature
of free donation without any strings attached. When compulsorily mandated on an
eligible Muslim, sadaqa is called zakat. When sadaqa results in flow of benefits that are
expected to be stable and permanent (such as, through endowment of a physical
property), it is called sadaqa jariya or waqf.
Zakat is an institution of philanthropy mandated by faith. It may also be seen as a
compulsory levy on every believing and practicing high-net-worth Muslim. From
a macroeconomic perspective, zakat is a source of recurring annual flow of funds. Since
Islamic law restricts the allocation of zakat funds to eligible beneciaries alone, that
primarily include the poor and the needy, zakat is potentially a major tool of poverty
alleviation. It is more in the nature of a safety net to take care of the basic necessities
of life of poor farmers who cannot afford them. Additionally, zakat funds can be used
in a variety of ways for the farmers; for skill enhancement, provision of start-up capital,
or pay off the debt of the over-indebted farmers as long as the beneficiaries suffer from
abject poverty.
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Waqf, which essentially implies the irreversible endowment of an asset of value
(e.g. real estate, cash) by a donor with a stipulation that the returns generated through
investment of the asset or the benefits flowing out of the asset are used for specified
purposes. Thus waqf, by definition, provides for a sustainable source of funds/ benefits
that may be targeted at the poor farmers.
To sum up, Islamic finance provides a fairly broad range of modes and mechanisms
that may be used for provision of financial and non-financial services and support to
the poor farmers. Often some or all of these charity-based, not-for-profit and for-profit
mechanisms are combined in models to provide holistic solutions to the problems of the
poor farmers, alleviate their poverty and help them enhance food security. In the next
three sections, we discuss some composite models of intervention that are recent and
deemed highly successful by observers.
3. Farmers’ empowerment program (Indonesia)
DDR is a pioneer in using Islamic philanthropic funds, such as, zakat, sadaqa and cash
waqf for alleviating poverty. The program for economic and social empowerment of
farmers by this leading non-government organization[17] in Indonesia seeks to provide
a solution to the multiple problems of limited land, declining soil fertility, high input
prices, limited capital, low and limited farming skills, unremunerative and fluctuating
crop prices. It has embarked on an organic farmers’ empowerment program called
Pemberdayaan Pertanian Sehat (P3S) that adopts a holistic approach involving
adjustment of cropping patterns and change in farmers’ attitude and preferences from
conventional farming to a semi-organic cultivation system. The intervention involves
gradual and continuous assistance, guidance and introduction to production facilities
that are safe, locally made and affordable, to biotech and low-chemicals system through
integrated and environment-friendly farming. The semi-organic cultivation system
reduces farmers’ permanent dependency on chemical agricultural inputs that are
expensive. With the user-friendly green agricultural technology, farmers can reduce
production costs while obtaining higher prices for the organic produce.
The organic farmers empowerment program (P3S) involves provision of farmland
on ijara (lease) and of capital for semi-organic farming with a view to bringing about
significant increase in farmers’ earnings. The empowerment process also involves
strengthening of farmers’ capacity as human resources and helping them get organized
as formal communities, called combined farmers groups (gapoktan). The intervention
ends when the combined farmers groups have developed the capacity to manage the
formal organization independently, putting in place partnerships with other
stakeholders to support the organization’s existence, and improved their bargaining
position in the market.
Farmers’ eligibility for P3S program is based on several criteria, e.g. income and
ownership, business potential and the farmers’ potential as human resources. The main
target group are poor farmers meeting the following criteria. The farmers’ family head
earns ⩽ two USD per day in rural areas, or ⩽three USD per day in sub urban areas.
The other criteria relate to condition of their house and ownership of assets. Approval
from local neighborhood based on the defined criteria is needed to confirm a poor
family’s eligibility for the program. The business potential criteria include: the
development potential, which reflects the ability to expand the business in scale and
scope, related to the raw materials availability, production capacity, market potency
and employment rate; the potential to create derivative businesses that allows more
employments and economic benefits for other beneficiaries; and the potential for local
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resources utilization. Besides the above, a farmer must be of minimum productive age
of 18 years or is married, with maximum age of 60 years; should have the vision for
developing business; should be able to work; and should not be enlisted as participant
of any other similar program.
3.1 Components of the program[18]
The empowerment program involves several stages. Stage 1 involves promoting
awareness or recognition of potential and the environment followed by building
comprehension that organization in the center-stage of this process must be started
with the community’s initiative through continuous strengthening of the organization.
The programs then aims to prepare a cadre of local farmers who would take over the
task of mentoring after the program ends; to provide technical support, associated to
the technical aspects of the production process, which includes the introduction and
implementation of organic farming technology and semi-organic farming, adaptation of
technology, development of pre-and post-harvest processes as well as access to
information. It seeks to assist the farmers in fulfilling their needs, both individually and
in groups, in a sustainable livelihood system. The overall objective is to maintain
a balance in the interests of all the stakeholders by enhancing the bargaining power of
farmers through their own cooperation-based institution.
The process of forming farmers’ organization involves the following stages. First,
individual farmers in groups of eight to ten form small groups. Next, several groups are
organized into a secondary group called a combined farmers’ group called gapoktan[19].
Finally, several gapoktans are combined to form the farmers’ cooperative.
Since a major problem for farmers is the lack of land ownership, one of the
components of the P3S program is the provision of leased land to farmers.
Once farmers groups are formed, the next stage is the leasing of land to each farmer at
an average land area of 25,000 m2 for each farmer or 2.5 hectares (six acres) for each
group. Farmers get lease land for one year with the rental fee of Rp 4,000.000 (USD 150)
per hectare per annum. In addition to the land lease package, farmers also receive
a package in the form of processing costs of land, direct costs of labor for one growing
season. Farmers are expected to use the organic agricultural inputs (saprotan) and
working capital funds of the enterprise. Labor fees are directly paid for the overall
processes of land production and harvest. Assistance is also provided in the form of
fertilizer, compost, plant pesticides, seeds, etc. The program through research has
developed its own organic agricultural input (saprotan) in the form of bio pesticide that
is local-based, affordable and environment friendly.
A major component of the empowerment program is institutional capacity-building.
Assistance for the strengthening of the institutional groups of farmers and farmer
groups (gapoktan) involves the following. Enhancing the capacity of farmers is done
through various forms of training in semi-organic agriculture as also in organizational
and financial management of farm groups and gapoktan administrators, establishment
of the gapoktan forum, as well as periodic monitoring and linking up to other
stakeholders and the market. For instance, during the process of cultivation of rice,
the tutoring process, both regular and irregular meetings, is done through visits to the
homes of the farmers. Tutoring is done through regular meetings of the Group once
a week. The process of transfer of appropriate technology and organic rice cultivation
is delivered through group meetings. An example of the move towards self-sufficiency
is a consensus made among farmers that each farmer must save up to 40 percent of
their harvest, which would initially be used to pay land lease for the following year.
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3.2 Zakat-funded programs
The organic farmers empowerment program (P3S) along with other economic
empowerment programs of DDR is funded with zakat. The funds dedicated to such
programs average about IDR 6.3 billion per year over the five-year period (2008-2012)
that hovers around 10 percent of total zakat resources available (see Table I). The low
dedication is attributable to apparent Shariah objections by some scholars who
emphasize on utilization of zakat for consumption alone in the short term. In the face of
a growing realization, however, that an emphasis on short-term may lead to a
dependency syndrome among the poor, and that the long term need of the poor is
economic and social self-reliance, DDR seeks to enhance the utilization of zakat for
community empowerment programs.
Among the major economic programs of DDR are: the masyarakat mandiri
(self-reliant communities), pertanian sehat (health/ organic farming), kampoeng
ternak nusantara (livestock development), Islamic microfinance (for-profit) in
addition to capacity building initiatives under Indonesia Magnificence Zakat. The
economic empowerment programs follow a similar model that involves interest-free
loan financing to groups from a pool created out of zakat funds. The key
distinguishing factor of this model is the phased building of self-reliant communities
and the creation of a community organization that would continue to provide
financing to the members.
The program has a clear termination and exit strategy. It withdraws from the region
and the program ends as soon as the community cadres are ready to take part in
maintaining program sustainability – financial and institutional. It ensures that a
community-based organization is a legal entity with adequate capacity to sustain
cooperation with all stakeholders. From a Shariah perspective, this ensures that the
“tamleek” condition of zakat is complied with, since the poor beneficiaries ultimately
become the owners of the local organization in a collective sense with transfer of assets
from the program to the local organization. Thus, the fact that they are borrowers in
the first instance does not appear to vitiate the “tamleek” requirement[20].
4. Credit and lease-based finance (Pakistan)
According to a survey by a group of researchers from Lahore University of Agriculture [21],
there are about 5.1 million farms in Pakistan. Of this, 93 percent are small and
marginal accounting for 60 percent of the total cultivated area. They also found that
about 70 percent of farmers participate in the credit market; a majority from
intermediaries charging exorbitant interest rates. Further, the farmers also believe that
they can save up to 25 percent in costs if they purchase inputs on cash. In addition,
given that farmers usually return the money after the sale of the crop, the study argues
that banks should participate in agricultural sector using bai salam as the mode of
No. Field program Program Funds (Rp billion) Beneficiaries
1. Organic farming 15 4.6 2,611
2. Livestock 9 6 997
3. Fisheries 52 11.1 6,175
4. For-profit microfinance 6 4.3 2,186
5. Research, in house and public training 150 5.6 5,164
Total 232 31.7 17,133
Table I.
Five-year details
on economic
empowerment
programs by DDR
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finance. A similar reasoning seems to underlie the design and development of salam
as an agri-finance product by Wasil Foundation, a leading Islamic microfinance
provider in Pakistan.
Wasil Foundation, formerly known as Centre for Women Co-Operative Development
(CWCD), is a not-for-profit company established in 1992. The aim of the organization is
to economically empower poor communities and assist them in developing their
businesses through micro credit and enterprise development programs. In 2009, Wasil
Foundation (formerly CWCD) extended its operations from conventional microfinance
to Islamic microfinance. Eventually, it discontinued conventional microfinance in 2010,
thus becoming a purely Islamic microfinance organization. The pioneering efforts of
Wasil Foundation in meeting the financing needs of different strata among the urban
and rural poor has resulted in a diverse range of products in its portfolio (see Table II).
Thus, Wasil has three products specifically targeted at the farming community. It
believes that farmers in Pakistan are traditionally skilled but lack capital. Its first
product based on bai salam is targeted at small farmers with up to five acre land
holding, who need money to grow their crops and to feed their families up to the time of
harvest. Under the salam agreement, Wasil makes payment of agreed price in advance
to the farmer against commitment to deliver agreed quantity of produce upon harvest.
It involves lower cost as compared to other alternatives and finance is provided against
a collateral in the shape of guarantee from community members or a charge on
available assets with the farmer, e.g. livestock. Wasil’s second product seeks to address
the issue of lack of land ownership among farmers through leasing. Wasil takes
agriculture land on ijara from the owners of the land in bulk and sub-leases the same to
farmers for agreed period in exchange of pre-determined monthly lease rentals. In case
of fruits/vegetable/flower farms the lease rental is paid in cash. In the case of wheat and
rice, the lease rental is paid in kind in the form of crops.
Wasil’s third product combines the concepts of ijara and salam and bases the whole
return on the principles of salam, which requires settlement of debt in terms of the
crops or produce. Under this agreement called Master salam, the farmer gets land on
rental plus cash as working capital to cover related costs and agrees to deliver a given
quantity of the crop to Wasil. A part of the repayment in terms of crop is towards
rentals on ijara while another part relates to salam. After the first cycle of finance, there
are two subsequent cycles of financing that are based on salam alone. After the two
additional salam cycles, the contract ends.
4.1 Risk factors and their mitigation
The main challenge concerning the salam transaction is the identification of the quality
of the crop and the determination of the price at which it must be procured. The
Government of Pakistan issues a support price for wheat at which the Food
Mode Target beneficiary
Zakat Destitute unable to work
Qard al-hasan Poorest of the poor with ability to work
Murabaha Micro level traders street hawker Small shopkeepers
Salam Small farmers up to 5 acre land holding
Ijara Farmers without land holding (rental land)
Diminishing Musharaka Micro entrepreneur in need of assets
Master Salam (Ijara + Salam) Developed by CWCD farmers in need of land plus money for cultivation
Table II.
Islamic finance
products by Wasil
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Department of Government of Pakistan procures it. However, when Wasil Foundation
approached these departments for the sale of crop, they refused due to the restriction
levied upon them by the Government of Pakistan whereby only a farmer may sell to
these departments. Thus, the only other options were the sale to the flourmills or to the
open market. Furthermore, unlike the support price at which the Government
purchases the crop, the flourmills and the open market rates are determined by certain
market factors including the quantity of national produce.
In order to determine the price, Wasil Foundation takes the data of the sale price in
a specific area over the last three years. This gives a rough estimate of what the price
is likely to be for the crop that is to be grown. Wasil Foundation then offers a float rate
at which the purchase price is negotiated with the farmer/client. This negotiation takes
place at the village level with groups of farmers who are likely to sell the crop to Wasil
Foundation. At the end of this negotiation, Wasil foundation determines a final price
at which it procures the crop. At times, this price may vary from area to area based on
the cost of production, the expected yield, the sale price of the area in the last years
and the amount of risk that the organization has to face.
In June of 2010, Wasil Foundation launched its first rice salam transaction. Unlike
wheat, the market rate of rice crop is entirely dependent on the quality of the crop
wherein the seed of the crop is of major importance. In the case of wheat, the seed being
planted does not directly affect the price, as the output crop is the same. In case of
rice crops, these are categorized in accordance to the seed that is being planted by the
farmer. Thus, the challenge of the quality of the crop and the proper identification
of the seed is of vital importance while conducting a salam transaction on rice. For
this, Wasil Foundation trained its procurement and sales department, through the
agriculture department of Government of Punjab, Pakistan, on the types of rice and
the identification techniques of rice.
Unlike wheat, there is no support price by the Government for rice, which makes
the estimation of the purchase price more complex for rice. The options open for
Wasil Foundation are again, as in the case of wheat, the selling of the crop to the open
market or the rice mills in the area. However, unlike wheat, when rice is harvested, it
contains a high moisture content due to which the total weight of rice is increased
by approximately 15-20 percent. This moisture further induces a chance for the crop
to be damaged if it is not dried up in time. These issues increase the risk of holding rice
at a warehouse for collection and sales purposes. Thus, unlike wheat, which may be
stored for up to three months by Wasil Foundation, rice is to be sold within a maximum
of one-month period due to the unavailability of the proper infrastructure to store rice.
This challenge still exists while conducting a rice transaction of salam.
The crux of the Master-salam product is the repayment in the form of crop rather
than cash. This makes enormous sense, given that the client/farmer is not rich in cash
during his crop cycles, which makes it difficult for the farmer to make the monthly
repayment in cash. However, the farmer/client is rich in crop at the time of harvesting.
Therefore, the product is focused on the principles of salam wherein the crop is delivered
as a repayment for cash inputs, plus for the extra input of land in the form of ijara.
5. Composite partnerships with farmers (Sudan)
A model that has been experimented in Sudan in the recent past adopts a composite
finance-plus approach to support the farming communities.While there are elements of
credit-based financing, the overall models are rooted in partnership. The underlying
rationale for this approach seems to be the pivotal role that the IsFIs see for themselves
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in addressing various problems of the poor farmers and in enhancing food security of
the region. While agriculture in Sudan faces problems similar to those in Indonesia
and Pakistan, the challenges here are even greater arising out of adverse weather
conditions, large tracts of drought-affected land and civil strife leading to a faltering
economy riddled with unemployment. Islamic microfinance in Sudan, however, has a
lot to offer in terms of its uniqueness and high success rate.
The microfinance program of BoK, known as IRADA, is experimenting with new
and innovative models of intervention to make inroads on chronic social problems, such
as, poverty and unemployment. As part of the Sudanese economic system, it operates as
a Shariah compliant bank. At the same time, it uses participatory modes within a model
that is rooted in cooperation to create and share wealth in the agriculture sector[22].
BoK was established in 2002 while its microfinance program (IRADA) was established
in 2009 with the support and assistance from the Islamic Development Bank. The
department was given the mandate to implement the SDG 200 million Al-Aman fund
for microfinance. The fund was formed by a strategic partnership between the Diwan
Zakah (apex body of zakat management in Sudan) and 32 Sudanese commercial banks.
IRADA was set up with a vision “to alleviate poverty and hunger by realizing the
potential of the poor through development of limited resources and affordable
financial facilities,” and a mission “to increase the numbers of poor people involved in
entrepreneurial activities through Islamic finance and expanding income generating
activities, creating sustainable livelihood and employment.” Its programs and
activities are influenced by its strategic approach theme, which states, “Today the poor
are our clients, but tomorrow they will be our business partners.” Since inception,
IRADA identified and focused on “economic empowerment through group finance
and partnership.”
5.1 Innovative use of zakat
In perhaps the first documented example of utilization of zakat for gharimeen (indebted)
in an organized manner, globally speaking, a security portfolio was created through a
partnership between the Diwan Zakah (apex body for zakat management in Sudan) and
commercial banks. The portfolio has a capital of 200 million pounds with 25 percent
contributed by the former and the balance by the banks. The portfolio provides an
insurance to the program against genuine defaults by clients at the second level. At the
first level, the default is covered by individual personal guarantor(s) brought in by the
client. The portfolio covers all productive sectors (commercial, agricultural and
vocational) across Sudan.
5.2 Business development services
IRADA has carefully developed a network of providers of business development
services on its payroll to provide a range of additional services to its clients. In many
ways, these officers are key to the overall success of the program with their ability to
source and procure the assets needed for the income-generating microenterprises and
their role in monitoring the clients. In fact, each client is assigned a business
development officer who is responsible for ensuring that the relevant asset is delivered
to client, that the supplier is paid, and that the client makes timely repayment to the
bank. The business development officers are also entrusted with the task of advising
the clients on how their business can be more profitable. They also use their network in
order to facilitate mutual exchange among their clients. The provision of business
development service is adequately incentivized.
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5.3 Abu-Halima Greenhouses Project
The Abu-Halima Greenhouses Project of IRADA, designed in 2011, uses a composite
model of intervention that combines several “smart” factors and is designed to address
several critical social issues including lack of food security, unemployment and
poverty. It aims to open new economic opportunities for young university graduates
with formal education in agriculture. The project in its current phase, targets economic
empowerment of 125 educated unemployed graduates and their families. The project
involves setting up 25 productive units of greenhouses with annual capacity
production of 1,200 tons of off-season vegetables using latest technology in the
industry and professional expertise using the partnership-based mode.
The business plan of the project is rooted in the economic peculiarities of the local
market for vegetables, which witnesses a major spurt in the vegetable prices because
of adverse weather conditions. The greenhouses would enable the micro-entrepreneurs
to grow high-value vegetables all through the year, while smoothening the supply
of vegetables in the Khartoum market. The greenhouses can now grow vegetables that
usually witness many-fold price rise during summer and other high-value vegetables
during winter, thus, reducing price volatility. The underlying model for the project
is presented in Figure 2.
The model (restricted mudaraba partnership). Unlike the regular micro-credit
products, or even the commercial mudaraba products, the partnership between the
bank and the micro-entrepreneurs extends well beyond that of a creditor and debtor or
that of a rabb-al-maal (fund provider) and mudarib (fund manager). The bank assumes
Min. of Finance IRADA – BoK
Abu Halima
Min. of Social Affairs Graduates
Min. of Agriculture
Tech Consultant
Sana Hypermarket
1
2
3
5
7
6
8
9
10
4
Notes: Arrows denote specific activities as follows: (1) financial partnership
between Ministry of Finance and BoK; (2) nomination of agriculture graduates for
the project by Ministry of Social Affairs; (3) Mudaraba agreement between
IRADA (BoK) and the micro entrepreneurs (agriculture graduates); (4) setting up
of Abu Halima greenhouses; (5) technical consultancy to micro entrepreneurs;
(6) technical consultancy to greenhouse establishment and operation;
(7) provision of fertilizers and other services by Ministry of Agriculture; (8) sale
of vegetables output to Sana Hypermarket and others; (9) sharing of profits
(40 percent for five years and 100 percent after that) by micro entrepreneurs; and
(10) sharing of profits (60 percent) by IRADA-BoK for five years
Figure 2.
The Abu Halima
Project
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responsibility for provision of financial as well as a range of non-financial services to
the micro-entrepreneur in the form of technical, marketing and business development
services. The latter involves direct investment in creation of assets for supply of
electricity, water as well as for vegetable cooling, storage and other services.
A beneficiary of this project must come from low-income strata of the Sudanese
society and the income of the household should not exceed two times the minimum wage
of USD 207 per month according to the law of Central Bank of Sudan. The beneficiaries
are organized into jointly liable groups of households (headed by graduates, preferably in
agriculture) in the form of a cooperative society registered according to the Sudanese
Cooperative Law. These groups enter into the restricted mudaraba partnership contract
with BoK. The micro-entrepreneurs receive the required technical training from experts,
managerial and marketing support from the bank. They are eventually organized into a
co-operative, which allows them to benefit from common facilities while retaining their
right to do business activities.
Other stakeholders and partners in the project include: Ministry of Finance, which has
made a social contribution of 6.5 percent of capital; the State Ministry of Agriculture,
which helps get fertilizers and assists in technical capacity building; the Ministry of
Social Affairs, which nominates the beneficiaries through its Graduate Fund; and Sanaa
food hypermart and home center – a major supermarket chain – which has committed to
off-take the vegetables. A technical Turkish firm, specializing in the technical aspects of
greenhouse projects is a significant contributor to the success of the project.
Financing method. The financing product is structured using the mudaraba mode
with profit and loss features. Losses would be absorbed by the bank while profits
would be shared in the ratio of 40 percent for the micro-entrepreneur and 60 percent for
the bank. Profit distribution would take place twice in a year. The “restricted”
mudaraba involves total financing to the tune of SDG 15 million (USD 4.50 million),
which accounts for about 6 percent of the total portfolio of IRADA. It involves
financing of working capital to purchase the 25 greenhouses, supporting infrastructure,
technical feasibility, technical capacity building, agricultural inputs and living
allowances. As stated above, the Ministry of Finance has contributed 6.5 percent of
mudaraba capital as a social contribution with a view to lower the costs borne by the
beneficiaries.
IRADA’s product package includes the services of an administrative coordinator,
and an agricultural expert to supervise the production process and technical matters,
ensure quality control and providing training. Such costs are included with the direct
cost of the product. IRADA would retain control of the venture for five years,
essentially to ensure its profitable operation. During this implementation period of five
years, the graduate micro-entrepreneurs would be trained to manage the ventures.
IRADA would cede control of the project assets to the cooperative as a gift or sale at a
nominal price after five years. Depreciation of assets is calculated at 20 percent per year
over five years. The only collateral that the bank would be seeking for this financing is
a personal guarantee against mismanagement and lack of commitment. There are no
financial or physical collaterals required. However, the households, through the
cooperative society, are required to submit a check as a security for default and
infringement. The title of the assets is in the name of BoK as the rab-al-mal during the
finance term, thereby, mitigating the asset-related risks. BoK, being the provider of the
funds (rab al mal ), has an insurance contract with the Islamic Insurance Company to
cover the assets against any loss.
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The returns on investment to IRADA would come in the form of 60 percent of
profits made on the sale of 1,200 tons of high value vegetables and fruits annually. This
is expected to generate an ROA of 18 percent and IRR of 22 percent for the bank.
Returns to the micro entrepreneurs would come in the form of balance profit share,
estimated at SDG 2,100 per family plus an additional living allowance of SDG 300-600
per family during the implementation period. The returns are expected to significantly
increase to SDG 7,000 per family, since IRADA would withdraw after this period and
the micro entrepreneur would receive full profit share.
A unique feature of the design of this microfinance model is the safety net during the
implementation period of five years. This makes enormous sense as the mudaraba
profits may display volatility while the basic needs of the micro entrepreneurs must be
taken care of on a priority basis.
Non-financing services. Another unique feature of this project is the magnitude and
variety in the provision of a multitude of non-financing intervention/ services to the
micro entrepreneurs. These may be listed as under: assistance to source and hire
technical firm to construct greenhouses and related infrastructure and to provide
technical support throughout project lifetime; pre-production support in the form of
seeds, fertilizers, pesticides, machineries, electric and water sources; at-production
support in the form of living expenses allowance, operational expenses, harvest
expenses, technical support; after-production support in the form of cooling storage
and grading room; assistance to source large customers such as DAL and Home Centre
to purchase produce; assistance to manage the project accounts; formation and
registration of cooperative of farmers; and transfer of ownership to the cooperative
upon its readiness to manage the business.
Risk management. An agri-venture like Abu Halima faces several risk factors,
many of which may lead to crop failure and consequently to failure of the project.
The success of the project hinges on mitigating these risks. Below we list some
major risk factors identified by BoK and the various measures contemplated to
address them:
• Inability to sell produce: contractual agreement with major customer(s) is in place
to purchase products at market price.
• Crop failure due to disease: program has provided the micro entrepreneurs
with fertilizers and ensured that they have the capacity to use appropriate
amounts.
• Crop failure due to heat: greenhouses have automatic temperature control.
• Crop failure due to lack of humidity: greenhouses have automatic humidity
control.
• Crop failure due to lack of water: drip irrigation system is developed to provide
water. Well is constructed to provide sufficient water.
• Electricity blackouts: program has provided generators that run on diesel to
function as backup electricity.
• Unmet consumption needs leading to a lack of commitment: families are provided
SDG 300-SDG 600 as living allowance every month all through the five-year
implementation period.
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• Lack of commitment by beneficiaries: BoK has retained an option to remove a
given beneficiary and replace them with another. Beneficiaries have to sign into
work and their performance is monitored. Bank has the prerogative to distribute
a larger proportion of profits based on performance and commitment.
• Conflict during distribution of profits due to different yields: profits of the micro
entrepreneurs and bank is based on the total production of all the greenhouses
and not on an individual greenhouse basis.
Challenges. Notwithstanding the apparent success of the model, several challenges
remain. The first set of challenges relates to the beneficiaries. First and foremost, the
project assumes that the beneficiaries come with the qualities and characteristics of a
micro-entrepreneur, especially when it relates to the agriculture sector. This is a strong
assumption. Many of the beneficiary-entrepreneurs may turn out to be deficient in
terms of their abilities, notwithstanding the training and capacity building inputs
provided to them. Behavioral traits, such as, indolence, apathy, negligence and
impatience are hard to change. To get over their deficiencies, several farming tasks are
outsourced and the cost is charged to the beneficiaries according to mudaraba rules.
Further, lack of financial acumen on the part of the beneficiaries is likely to deter a
proper understanding of the mudaraba contract and its implications in terms of rights
and obligations of the parties. The second set of challenges is institutional. Compared to
traditional banking and microfinance products, micro-mudaraba is a new financing
methodology that requires developing much of the procedures and mechanisms de
novo. At the same time, these are likely to be more complex, especially when these
involve multitude partners. The third set of challenges come from a lack of an enabling
environment, such as, weak mudaraba laws. A major challenge may be in the nature of
political interventions that send a wrong signal about the product being noncommercial.
Macroeconomic developments, such as, high inflation rates may also
wreak havoc on financial estimates.
5.4 Wad-Balal livestock development
Livestock production is an important component of the local economy in Sudan,
providing food, employment, foreign exchange earnings, a source of wealth, and supply
of inputs and services, such as draught power, manure and transport. The livestock
subsector however, faces numerous constraints, including a heavy disease burden, low
productivity exacerbated by drought and insecurity, the lack of adequate marketing
infrastructure, and poorly organized and informed livestock owners and traders. The
Wad Balal cattle fattening project of IRADA involving an investment of SDG 9.30
million (about USD 1.68 million) aims to curb poverty by addressing many of the above
problems. The project aims to produce 7,000 cattle annually meeting export standards,
link the poor livestock herders with international markets utilizing contacts of the
Sudanese diaspora and increase incomes of an estimated 250-300 poor families. The
model underlying the project is presented in Figure 3.
The model. The model of intervention involves three parties – IRADA of BoK; the
Wad Balal Company owned by a group of Sudanese diaspora in the GCC; and the Wad
Balal Association with cattle farmers as members. Under the arrangement, IRADA will
have a diminishing musharaka agreement with the Wad Balal Company to invest in the
required physical assets and create a facility for fattening of the calves. The Company
will provide the technical services for the project. The Musharaka will provide the
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facility/assets on ijara or lease to the Association comprising the farmers. IRADA and
the Company will share the lease rentals from the farmers, as received by the
Musharaka. The latter will buy out the share of the former over a period of five years
by using a share of its profits. Further, a pre-agreed share of the profits of the Company
would be used to provide social benefits to the local community. The Association will
sell all the cattle post-fattening to the Company, which will ensure quality standards
and export the same to international markets. At another level, IRADA will provide
murabaha financing for purchase of calves to the Association. Murabaha financing in
bulk reduces the cost of purchasing calves. The project, by facilitating the production
of 7,000 export quality cattle every year and, by linking the farmers to the international
markets, enhances incomes of 250-300 poor families.
Financing method. The musharaka between IRADA and Wad Balal Company
was formed with 95 percent of capital contributed by the former (amounting to SDG
5.04 million) and 5 percent by the latter. The musharaka would make direct
investments in hangers, electric sources, water sources, and fattening supportive
investment that include cooling storage, services facilities, securities facilities, living
allowance of beneficiaries and technical support. The financing tenure is five years.
The lease of the cattle fattening facility to the association would bring in rentals at
18 percent per annum on ijara of assets used for cattle fattening to the association.
The revenues from ijara is shared between Wad Balal Company and BoK as per the
agreed terms of diminishing musharaka. The murabaha financing amounting to SDG
4.26 million will involve murabaha to purchase calves for Wad Balal Association at
IRADA – BoK Wad Balal Company
Fattening
Wad Balal Facility
Association
Farmers
Tech Consultant (WBC)
3
1
2
6
7
4
5
OVERSEAS MARKET
8
Notes: Arrows denote specific activities as follows: (1) diminishing Musharaka
agreement between BoK and Wad Balal Company (WBC) to create fattening
facility; (2) Bok helps farmers form Wad Balal Association (WBA); (3) Murabaha
agreement between BoK and farmers represented by WBA to finance purchase of
calves; (4) Ijara agreement between Musharaka and WBA to use facility in lieu of
payment of rentals; (5) use of fattening facility by farmers to make the calves
grow; (6) technical consultancy and training by WBC; (7) delivery of cattle by
farmers to WBC; and (8) sale of cattle by WBC in overseas markets
Figure 3.
The Wad Balal
Project
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15 percent profit margin. BoK will provide 100 percent financing for calves in the first
two years; which will gradually reduce to 25 percent in the fifth year.
Non-financing services. As before, this initiative also involves a multitude of nonfinancing
intervention/services that include the following: technical support throughout
project lifetime to ensure production quality and cattle vet services, establishing linkage
with Wad Balal Company with access to market in GCC countries, assistance in
managing the project accounts, and formation of Wad Balal Association of farmers.
Risk management. An agri-venture like Wad Balal faces several risk factors,
many of which relate to the marketability of the cattle that are reared by the farmers.
The success of the project hinges on mitigating these risks to acceptable minimum.
Below we list some major risk factors identified by BoK and the various measures
to address them:
• Diseases: the project provides on-site veterinarian services to treat and prevent
cattle diseases.
• Lack of quality and specifications (e.g. health, weight) for export market: on-site
technical services are provided to educate farmers how to raise the quality of
their livestock and meet international standards.
• Unmet basic needs of farmers: families are provided living allowance.
• Inability to market: the Wad Balal Company, which has strong export, links with
the GCC countries have committed to purchase the cattle at a fair price.
• Lack of commitment by farmers: this risk is mitigated considerably by retaining
the right with BoK to remove a shirking beneficiary and replace with another
committed worker. This is backed by stringent performance monitoring. Good
performance is also incentivized with BoK having the right to distribute a larger
proportion of profits based on performance and commitment. Performance of
individual farmers is also monitored at the Association level.
5.5 Building strategic food reserve
Under another program involving multiple partners, IRADA microfinance aims to
purchase goods efficiently from farmers for sale to the Government of Sudan’s strategic
food reserve. This would replace the intermediary and ensure a better price for farmers
for their produce based on official advance purchase rates determined by the Ministry
of Agriculture. This ensures that the farmers’ incomes increase and more farmers are
motivated to produce for livelihood in addition to subsistence. The other partners in
this program are the Ministry of Agriculture and the Ministry of Social Welfare of the
government of Sudan, the Zakah Chamber of Sudan and the World Food Program.
Under this program, IRADA provides salam financing with a tenure of a maximum
of eight months. Its target beneficiaries include 73,000 smallholders under 878 Farmers
Association in seven states (23,677 through direct contract, and 48,396 through
mudaraba with other commercial banks). The program involves multiple parties in a
multitude of roles. IRADA serves as the link between the farmers and other partners
and in grouping the farmers into associations. The Ministry of Agriculture provides
technical assistance for product quality and building the capacity of farmers groups.
The World Food Program provides food for farmers during the planting period.
Finally, IRADA provides for coordination and monitoring of partners activities and
links farmers to local, regional and global markets.
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6. Lessons and way forward
Agricultural growth has a direct impact on poverty by raising farm incomes. It indirectly
impacts poverty through generating employment and reducing food prices. When
centered on smallholder farmers, it requires creative and innovative interventions that
involve provision of a range of financial and non-financial services to them. The latter
include technical skill enhancement of the farmers as well as their empowerment through
producer organizations. This paper undertakes a review of a range of interventions
that have been undertaken in recent years to achieve the same in the Islamic framework.
An alternative approach has been attempted in these experiments. This is based on the
argument that the conventional products and services may not be acceptable to farmer
communities in the Islamic societies, since these violate some fundamental religious
and cultural norms. The key lessons from the case studies included in the paper are
highlighted below.
The conventional lending methodology for the rural poor is rejected in the Islamic
framework on a fundamental ground. Islam prohibits any gain or price for credit.
It does not permit any increase in the quantum of debt due to what we know as the
“compounding of interest.” Thus, while Islamic finance includes products that create
debt, it curbs automatic expansion of credit. Given that the clients come from the
poorest strata of the society, there is merit in a more “humane” form of credit that rules
out penalties for genuine delays in repayment. The paper presents the case of IsMFIs
offering bai muajjal, murabaha, ijara, bai salam where the quantum of debt obligation,
once created and determined, is not permitted to take any other value due to its
restructuring. Nor are penalties a source of income for them.
A review of various Islamic modes that are used for provision of finance to farmers
reveals that there is no one-size-fits-all mode, even though bai salam is widely seen to
be the appropriate mode for agricultural finance. Further, Shariah-compliance of a
mode does not by itself ensure freedom from exploitation. As the examples show,
salam can often involve exploitation when the advance price paid to the poor farmer
is artificially pegged at low levels due to his/her weak bargaining power. Identifying
appropriate organizational structure, e.g. a farmer’s cooperative, may replace the
vendor and thus prevent exploitation of individual farmers by the latter. Similarly,
rates on murabaha and ijara financing can be and often are exploitatively high.
In case of participatory modes e.g. mudaraba, musharaka and muzara’a the sharing
ratio could be unfairly biased against the poor beneficiary because of their low
bargaining power. Prudential regulation of markets is an important pre-condition to
ensure healthy and adequate competition among the players and thereby, remove
abnormal and/or illegal profits through mispricing. Of course, these “exploitation”
concerns apply to for-profit modes only and call for a greater reliance on not-for-profit
modes of microfinance.
Islamic finance discourages debt based products and encourages equity and
partnership based products in general. Given that conventional MFIs derive their
income from interest, they seem to be inclined to push their clients into larger and
larger amounts of debt. In the Islamic approach, debt is not just discouraged; there are
built-in mechanisms, such as zakat to address over-indebtedness of an individual.
The paper documents the cases in Sudan where an institutional mechanism exists for
use of zakat for curbing indebtedness.
Islamic finance requires “simplicity” in contracts where the rights and obligations
of the parties are well understood by them. Even where an Islamic finance model
includes future obligations, or composite structures, the uncertainty and ambiguity
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factor is kept to the minimum. The diminishing musharaka based models used in
Sudan are apparently complex but quite “definitive” in terms of transfer of ownership
of the key assets into the hands of farmers over a finite period.
While credit and finance are key inputs for transforming the lives of the farmers,
they often require a wide range of non-financial services. Identifying these nonfinancial
needs and finding creative and innovative solutions thereto is critical for
success of any intervention. The paper documents a range of such services provided in
Indonesia, Guinea and Sudan in particular including: technical assistance, skill
enhancement, procurement, production, warehousing, processing, packaging and
marketing support that underlies the success of these interventions.
A related question is how these non-financial services are to be funded. Should they
be priced? Should the farmers pay for these services? The cases documented in this
paper highlight both commercial and philanthropic approaches to the issue. While in
the Sudanese examples, the costs are duly accounted for in the determination of profitshare
for the farmers, the Indonesian experiment provides a zakat-funded approch.
Indeed the inter-mix of philanthropy with a commercial approach is a key feature of the
case studies discussed in this paper.
MFIs that focus on financing the need for physical assets by farmers through
conventional or Islamic credit, or through leasing often ignore the importance of
providing for basic consumption needs. It should not come as a surprise if farmers
resort to diversion of funds from the so-called income-generating project or even
distress sale of the assets (funded by MFIs) if the basic consumption needs remain
unfulfilled. Indeed, in case of the Sudanese projects the provision of safety net by
IRADA is perhaps a significant contributor to the success of the projects.
Community-driven development (CDD) is a recent experiment in poverty alleviation.
Despite the success of this approach, a major constraint with conventional CDD is the
recurring nature of funding requirement while recurring grants may not be
forthcoming. This paper documents a case in Indonesia where zakat is used to fund
subsequent phases of CDD. The Islamic CDD is free from the constraints facing its
conventional counterparts, given that zakat is an annual recurring flow unlike the
conventional grants that may be one-time or erratic at best.
The projects discussed in this paper not only seek to leverage existing skills,
but also develop new skills. Specifically, the Indonesian and Sudanese
interventions seek to take the technical skills of farmers to a completely new level,
which should enable them to create wealth by applying better farming technology on
a sustained basis. The Sudanese projects in particular use an approach similar to
conventional venture capital funding (with some differences, of course) and focus
on the economic viability of project. They carefully seek to identify risks and
mitigate them. They also provide a unique example of combining benevolence with
commercial viability.
To summarize, the case studies presented in this paper provide insights into the
alternative modes and models of Islamic microfinance that are in use to provide
livelihoods, socially and economically empower the farming communities, enhance
food security and alleviate poverty. The need for these solutions arises due to possible
self-exclusion of farmers from conventional microfinance on the ground of their
incompatibility with religious beliefs. The models and tools of Islamic microfinance
display major variations as they seek to provide financial and non-financial support to
the farming communities. While some IsMFIs focus on the provision of micro-credit
to farmers, following an approach similar to that of conventional agri-finance
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and microfinance institutions while ensuring Shariah-compliance of their credit
product(s), a few others prefer a more comprehensive and challenging approach.
The latter group of IsMFIs assume that an MFI must play the role of a pivot in
a process of transformation, and in the economic and social empowerment of the
farming communities. These IsMFIs adopt a “project” approach and provide support in
a multitude of areas other than finance, such as, technology, procurement, production,
marketing, business development, capacity building, and thus, ultimately steering
the project to success.
However, in confronting the multitude of challenges facing the farming
communities, the MFIs may have to limit their outreach significantly. While in case
of credit-based finance, the size of financing per beneficiary is very small, perhaps in
the range of USD 100, the same is very high in case of project-based approaches that
seek to finance the entire value chain. Such partnership-based agri-finance may require
large upstream investments; perhaps placing them in a distinct category of social
impact investment and not in that of microfinance. For instance, the size of financing
per beneficiary is capped at USD 32,000 in case of Abu Halima Green Houses project.
No wonder, while salam-based microfinance by IRADA directly targets over 23,000
farmers, Abu Halima targets a meager 125 agriculture graduates. This naturally raises
the question: Is salam financing the best that Islamic finance can offer in the field of
agriculture? At the same time, it is important to note that projects like Abu Halima
and Wad Balal may have a far more significant long-term impact in terms of
building capacities of farmers as also in enhancing food security. Such projects
help create a new generation of technically superior and highly skilled farmers
increasing the supply of and stabilizing prices of high-value foods. Further replications
of such projects would also bring down the marginal costs. Another unexplored
possibility in Islamic finance is the establishment of awqaf or endowments to take
care of the upstream investments that create permanent or long-lasting facilities for use
of farmers. Such investments need not be funded with bank finance. If so, the quantum
of financing per beneficiary will significantly go down and the outreach of IsMFI may
be significantly increased.
Another interesting dimension of the Abu Halima and Wad Balal projects is the
contribution of grant money by the Ministry of Finance to the Mudaraba, which makes
it possible to offer murabaha financing at a modest rate of fifteen percent. Given the
widely expressed concern about affordability of high-cost microfinance, such a
possibility offers great promise. In a modified model, the Ministry may easily be
replaced with a dedicated waqf, which can pave the way for affordable microfinance for
the poor.
A unique dimension of the Wad Balal project is the fact that a pre-agreed share of
the profits of the Wad Balal company (that serves as the pivot in the structure and
would be eventually owned entirely by the Sudanese diaspora) would be used to
provide social benefits. One may draw a line of comparison between such a corporate
entity and a waqf, which dedicates a certain percentage of its profits for provision of
specific social benefits. Indeed, with minor variations, the two project structures could
easily fit in new situations and find acceptance in a variety of countries and regions. In
the Sudanese scenario, several ministries of the government contribute significantly to
the success of the projects. The active involvement of the ministries of the government
in other countries may give rise to apprehensions and concerns about coordination and
efficiency. As an alternative, the substitution of the institution of waqf for government
may be explored.
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Notes
1. Together, these three countries account for over 440 million of the world Muslim population
(see Central Intelligence Agency, 2014).
2. Food and Agriculture Organization (2013).
3. Pakistan Economic Survey (2014).
4. World Bank (2003) defines smallholders as those with a low asset base, operating less than
two hectares of cropland.
5. The 1970 Unregistered Land Act ensured that any land, occupied or unoccupied, which had not
been registered before the commencement of the Act would be the property of the government.
6. US Country Studies, Library of Congress (1991); also Zaroug (2000).
7. Busschaert (2014) discusses the concept of microfinance for agriculture investment in small farms
(MF4SHF) and presents the mechanism to create high and long-term impact in small farms.
8. For a comprehensive discussion on the Shariah-compliant modes of microfinance, see
Obaidullah (2008a, pp. 55-64).
9. Riba and Gharar being Arabic terms can only be loosely translated. Riba is translated as “excess”
or “growth” and generally implies usury. Gharar is translated variously as “uncertainty”, “risk” and
“ambiguity”. For a comprehensive definition of riba and gharar, see Obaidullah (2005, pp. 21-35).
10. For a comprehensive analysis of istijrar and its possible applications, see Obaidullah (2005,
pp. 190-192).
11. The Grameen model is the text-book model of conventional microfinance that uses jointliability
and group financing as a substitute of collateral in mitigating high credit risk with
the rural poor.
12. For example, neither the price of a cow and a goat are same, nor can one buy, say, one and
half goats for a pre-determined amount of funding. For a case study of RDS, see Obaidullah
(2008b, pp. 14-43) and for a more recent version, Obaidullah and Shirazi (2014, pp. 88-94).
13. See Obaidullah (2014).
14. See Obaidullah and Saleem (2011, pp. 206-216).
15. For a discussion of the Iranian Qard al-Hasan Funds, see Obaidullah (2008a, pp. 37-38).
16. For a case study of Akhuwat see Obaidullah and Shirazi (2014, pp. 81-88).
17. For a comprehensive report on the programs of DDR, see Obaidullah et al. (2014, pp. 66-69)
and Alim (2014).
18. For further details on this program, see Mintarti (2013) and Alim (2014).
19. Gapoktan is a term in Bahasa Indonesian language that refers to small groups.
20. The Arabic term “tamleek” translates into “imparting ownership”, which is an essential
condition for zakat distribution to any beneficiary. For more on this issue, see Obaidullah
(2013, pp. 60-61).
21. See Kaleem and Abdulwajid (2009, pp. 275-292). The estimated percentage of small farms is
larger as compared to the IFPRI (2005) estimate cited earlier.
22. Not surprisingly therefore, it was adjudged to be among the top three participants (Wasil
receiving the top award) at the Global Islamic Microfinance Challenge 2014 organized by the
CGAP (Consultative Group to Assist the Poor), the Islamic Development Bank, Al Baraka
Banking Group and Triple Jump, which evaluated innovative Islamic microfinance
experiments with a focus on product development.
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References
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Kaleem, A. and Abdulwajid, R. (2009), “Application of Islamic banking instrument
(bai salam) for agriculture financing in Pakistan”, British Food Journal, Vol. 111 No. 3,
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Karim, N., Tarazi, M. and Reille, X. (2008), “Islamic microfinance: an emerging market niche”,
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islamic-microfinance-emerging-market-niche (accessed February 24, 2015).
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Zakat, Dompet Dhuafa Republica.
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community empowerment”, in Atbani, F. and Trullols, C. (Eds), Social Impact Finance,
Palgrave Macmillan, Hampshire, pp. 75-96.
Obaidullah, M. (2005), Islamic Financial Services, Scientific Publishing Center, King Abdulaziz
University, Jeddah.
Obaidullah, M. (2008a), Introduction to Islamic Microfinance, IBF Net, India.
Obaidullah, M. (2008b), Role of Microfinance in Poverty Alleviation, Islamic Research and
Training Institute, IDB, Jeddah.
Obaidullah, M. (2013), Zakat Management for Poverty Alleviation, Islamic Research and Training
Institute, IDB, Jeddah.
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experience”, paper presented at Third Islamic Microfinance Symposium organized by
GIZ and the Tunisian Islamic Economics Association, Tunis, March 5-6.
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Muslim Aid’s Sri Lankan experiment”, in Ali, S.N. (Ed.), Shari’a Compliant Microfinance,
Routledge Publishers, New York, NY, pp. 206-216.
Obaidullah, M., Shirazi, N., Muljawan, D. and Izhar, H. (2014), Islamic Social Finance Report 2014,
Islamic Research and Training Institute, IDB, Jeddah.
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countrystudies.us/sudan/55.htm (accessed February 24, 2015).
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Further reading
CGAP (2014), “Pakistan’s Wasil Foundation wins Islamic microfinance challenge”, available at:
www.cgap.org/news/pakistan’s-wasil-foundation-wins-islamic-microfinance-challenge
(accessed October 20, 2014).
Corresponding author
Dr Mohammed Obaidullah can be contacted at: [email protected]
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Enhancing food security with
Islamic microfinance: insights
from some recent experiments
Mohammed Obaidullah
Islamic Development Bank, Islamic Research and Training Institute,
Jeddah, Saudi Arabia and
Faculty of Muamalat and Administration,
Islamic Sciences University Malaysia, Kuala Lumpur, Malaysia
Abstract
Purpose – Islamic microfinance institutions (IsMFIs) have used diverse models and tools, as they seek
to provide financial and non-financial support to the farming communities. A majortity of IsMFIs
focus on provision of micro-credit to farmers alone as a means to enhance food security, following
an approach similar to that of the conventional microfinance institutions. Others adopt a “finance-plus”
approach and provide support in a multitude of areas other than finance, such as, technology, production,
marketing, business development, capacity building, and thus, ultimately steering the project to success.
The purpose of this paper is to examine the models and tools of Islamic agricultural finance for the rural
poor that display major variations and draw lessons from a policy perspective.
Design/methodology/approach – The study undertakes a comprehensive review of the principles,
modes and models of Islamic agricultural finance targeted at small-holder farmers. It uses a case study
method to review several winning initiatives by IsMFIs across the globe. It highlights the various risks
and challenges confronting the projects and how the same are sought to be mitigated.
Findings – Islamic agricultural finance for the rural poor involves a range of modes, mechanisms
and institutional structures. Credit-based and sharing-based modes work well under specific conditions
and there is no one-size-fits-all solution for financing the rural poor. Case studies of successful
initiatives reveal that composite models involving the integration of philanthropy-based, not-for-profit
as well as for-profit components may provide ideal solutions. Additional factors critical for success
include provision of safety nets, involvement of community, non-financial support in a multitude
of areas other than finance, such as, technology, procurement, production, marketing, business
development and institutional capacity building.
Originality/value – The paper addresses a fundamental issue in financing the poor farmers
in Muslim societies – whether to opt for a credit-based approach that would ensure greater outreach
or to go for a holistic intervention involving financing of the entire value chain. The findings are based
on personal interaction of the author with professionals directly involved in the projects.
Keywords Food security, Agriculture finance, Islamic microfinance, Livestock finance
Paper type Case study
1. Introduction
Agriculture plays a major role in enhancing food security and employment
opportunities in several countries with large Muslim population, such as, Indonesia,
Pakistan and Sudan[1]. It is a significant contributor to the gross domestic products
(GDPs) in these countries. In Indonesia, it accounts for over 15 percent of GDP with
around 40 percent of the working population employed in this sector[2]. In Pakistan, the
corresponding figures are 21 and 45 percent, respectively[3]. In Sudan as well, it is
estimated that the sector contributes 35-40 percent of the GDP. Yet, there has been a
growing incidence of the farming community in these and other countries seeking
alternative sources of livelihood triggering concerns about food security. Key factors
Agricultural Finance Review
Vol. 75 No. 2, 2015
pp. 142-168
©Emerald Group Publishing Limited
0002-1466
DOI 10.1108/AFR-11-2014-0033
Received 5 November 2014
Revised 28 December 2014
26 February 2015
Accepted 19 March 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/0002-1466.htm
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contributing to this in Indonesia include, among others, declining soil fertility, high
input prices, limited capital, human resources with low and limited skills, fluctuating
crop prices and above all, continuously declining terms of trade (Mintarti, 2013). In
Sudan, the problems are further accentuated due to natural calamities in the form of
droughts and civil strife. In Pakistan too, the story is similar. Land access is increasingly
becoming a key constraint for many farmers forcing them to seek migration to urban
areas in search of alternative sources of livelihood. Studies also show that these
countries are characterized by large and increasing number of small farm holdings[4].
An IFPRI (2005) study estimates that Indonesia has about 17.2 million small farms
accounting for 88 percent of all farms, while Pakistan has about 3.8 million small farms
that constitute 58 percent of all farms. The numbers are also steadily increasing along with
a decline in average size of holdings. For example, the average size of holding in Indonesia
declined from 1.1 hectare to 0.9 hectare over 1973-1993, the same for Pakistan declined
from 5.3 hectares in 1971-1973 to 3.1 hectares in 2000, during which time the number of
small farms more than tripled. Sudan presents an interesting contrast with the
government owning large tracts of agricultural land[5]. Agricultural holding size varies
according to the region and system of production. For example, in central Sudan the
government has proactively encouraged mechanized and large-scale farming. The rest of
the country has private small-scale farming where the size of holding has continuously
declined due to fragmentation because of the operation of the Islamic law of inheritance[6].
Small-scale farmers are the “economically active” poor who witness grave food
insecurity and abject poverty. Agriculture is highly dependent on the local conditions:
availability of and access to good land, soil, water, climate and market. Further, crops
vary widely in terms of duration, perishability, and seasonality. Therefore, provision of
microfinance requires different products, diverse and tailor-made approaches. Recent
best practices in conventional microfinance advocate “local” interventions based on a
value chain approach[7].
A major challenge confronting such microfinance is related to the belief systems of
the farmers. Conventional microfinance involves interest-based savings and loans to
farmers, which is against the tenets of Islam, the predominant religion in the countries
under focus. A study by Karim et al. (2008) undertaken for CGAP based on a survey of
the poor in Muslim societies concludes that Islamic microfinance, that is in compliance
with the religious tenets “has the potential to combine the Islamic social principle of
caring for the less fortunate with microfinance’s power to provide financial access to
the poor. Unlocking this potential could be the key to providing financial access to
millions of Muslim poor who currently reject microfinance products that do not comply
with Islamic law.” Islamic microfinance, therefore, is seen as a solution to the challenge
of self-exclusion.
Several Islamic microfinance experiments have been undertaken in recent times in
predominantly Muslim countries. These poverty alleviation initiatives by the Islamic
microfinance institutions (IsMFIs) in the rural areas have sought to counter food
insecurity and generate livelihoods by focussing on the agricultural and livestock
sectors. IsMFIs have used diverse models and tools of Islamic microfinance, as they
seek to provide financial and non-financial support to the farming communities.
A majority of IsMFIs focus on provision of micro-credit alone to the farmers, following
an approach similar to that of the conventional microfinance institutions. Wadud (2013)
for example, argues that policies, which extend microcredit and ensure fair, timely and
low-cost delivery of microcredit to marginal and small farmers, could lead to reduction
of agricultural farm inefficiency and hence, lead to improvement of performance of
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farms. This could enhance farm output and welfare, help reduce poverty and improve
food security. Of course, the IsMFIs that offer microcredit must additionally ensure that
the credit product(s) offered by them are based on Shariah-compliant modes, such
as, murabaha, bai muajjal and bai salam[8]. Other IsMFIs prefer a more comprehensive
and challenging approach. These IsMFIs believe that they must play the role of an
anchor and a facilitator in a process of transformation, and in the economic and social
empowerment of the farming communities. They prefer to adopt a “project” approach
and provide support in a multitude of areas other than finance, such as, technology,
production, marketing, business development, capacity building, and thus, ultimately
steering the project to success.
The aim of this paper is to introduce the reader to the basic principles of Islamic
microfinance as applied to the agricultural and rural sector. It seeks to highlight the
diversity in Islamic agricultural and rural financing modes and models and to underline
their potential reach and richness. The objectives include, among others, a comprehensive
micro-level analysis of selected experiments in agricultural microfinance in diverse
scenarios. The study uses a case analysis method to present the alternative approaches
and composite models and seeks to draw lessons therefrom so that the good practices may
be replicated elsewhere and bad practices, if any, may be avoided.
In the following section, we undertake a general discussion of the principles
and modes of Islamic agricultural finance as undertaken in a majority of case studies.
The following three sections present a few successful composite models of intervention.
Section 3 presents a case study of economic and social empowerment of farmers by
Dompet Dhuafa Republika (DDR), a leading non-government organization in Indonesia.
Section 4 presents a case study on an award-winning agri-finance product portfolio
by Wasil, a pioneering non-government organization in Pakistan. Section 5 presents
case studies of three unique projects of the microfinance unit (IRADA) of the Bank of
Khartoum (BoK) in Sudan. Section 6 summarizes the key lessons and concludes.
2. Islamic framework for agricultural finance
The Islamic framework for agricultural finance seeks compliance with several
fundamental Shariah norms. The two most important and relevant norms are:
prohibition of riba and prohibition of excessive gharar[9]. The first essentially rules out
any financial or non-financial gains for the lender offering credit-based products. The
second rules out excessive risk, uncertainty, undue complexity and conditionality in the
financial products. Islamic finance literature identifies several modes for provision of
agricultural finance that conform to the above. While some of these modes are sale or
lease-based and create debt obligations on the part of the farmer, others are sharingbased
and create partnerships between the farmer and the financial institution.
2.1 Bai muajjal-murabaha (credit-cost plus sale)
Bai muajjal is a sale where payment of price is deferred to a future date. Often it
includes features of a murabaha, which implies a sale on a cost-plus basis. As a microcredit
product, bai muajjal-murabaha is the most popular product among IsMFI
accounting for over two-third of the total Islamic microfinance portfolio (El-Zoghbi and
Tarazi, 2013). The mechanism may be described as follows. Farmer A needs to
purchase farm equipment or livestock X. He approaches the IsMFI. Now, the IsMFI
buys X from the vendor/supplier at price P. Next, IsMFI sells X to A at a marked-up
price, say P+M, where Mis the agreed profit or mark-up taken by IsMFI. The payment
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of price P+M is deferred to a future date and is made in full or in parts. This Islamic
credit product comes very close to the conventional interest-based credit, which
perhaps explains its popularity with the IsMFIs. Yet, there is a clear line of distinction
between the two. The quantum of debt created under the former is the price of the
underlying commodity that is fixed at the time of contracting and that remains at this
level even if the maturity of the product is extended subsequently. In conventional
credit products, however, the quantum of debt increases, compounded at the interest
rate as maturity increases (as in case of loan restructuring).
Bai-Istijrar is a variant of the bai-murabaha and takes place when the buyer
purchases different quantities of a given commodity from a single seller over a period
of time. Istijrar permits greater flexibility in the matter of fixation of price, which may
now be deferred to a future date (and not at the time of contracting as in bai-murabaha)
and may indeed be based on a normal price or average price in a volatile market.
This mode, thus, offers a natural way to reduce price risk. Though ideal for rural finance
where farmers often buy their raw materials and inputs in small quantities from the same
IsMFI over extended periods, istijrar has not been used extensively to date[10].
Several studies (Obaidullah, 2008b) and (Obaidullah and Shirazi, 2014) have
documented the case of the Rural Development Scheme (RDS) of the Islami Bank
Bangladesh that replicates the Grameen model[11] but uses bai muajjal (replacing
Grameen interest-bearing loan) as its primary mode of meeting the financing needs
of the farmers and the rural poor. The case studies highlight some possible issues of
Shariah non-compliance. For instance, in bai muajjal finance, one would expect the
amount of financing to vary, given that the wide range of commodities being financed,
have different prices. RDS on the contrary, provides a uniform financing amount,
similar to the basic loan of Grameen. This involves practical impossibilities, since
many commodities are not perfectly divisible and be the subject of exchange in
fractional units[12]. Further, bai muajjal may not be suitable for financing all kinds of
income-generating farming activities, such as, growing vegetables, fishing and other
agri-based activities. While bai muajjal can be used to finance the purchase of saplings,
fertilizer, fishing nets and so on, in practice, the farmers would need funding not just
for the physical asset(s) involved, but also to finance the working capital requirement.
Bai muajjal, thus, provides a partial solution only.
Another issue with RDS use of bai muajjal arises out of the Shariah requirement of
settlement of each of the two sale transactions sequentially in a single bai muajjal.
In a scenario where farmers need to buy their raw materials and inputs in small
quantities repeatedly, meeting the above Shariah requirement in bai muajjal may
involve substantial non-financial costs. As mentioned above, the use of bai istijrar in
such cases is possible and desirable too, as it can reduce such transaction costs.
However, its potential remains largely untapped.
2.2 Ijara (leasing)
Ijara in simple terms implies leasing or hiring of a physical asset. It is also a popular
and flexible product in which the IsMFI owns a physical asset (e.g. land, farm
equipment) and leases the same to the farmer. The farmer in need of the asset receives
the benefits associated with its ownership against payment of predetermined rentals.
In ijara, the risks associated with ownership of the asset remain with the IsMFI and the
asset reverts to the IsMFI at the end of the ijara period. Ijara is, therefore, similar to
conventional operational lease (though there are finer points of distinction including
use of penalties and interest in some scenarios). Ijara works well in a scenario where the
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IsMFI is organized as a farmers’ cooperative or an organization that primarily serves
the farmers. Pure financial intermediaries prefer a lease ending with ownership of the
asset by the lessee-farmer. In such an arrangement, the cash flows are structured in
a way that cover the cost of the asset and provide for a fair return on the same to the
IsMFI. The IsMFI after recovering its cost and fair return may simply donate the asset
or sell the asset at a nominal price to the farmer.
2.3 Bai-salam (deferred delivery)
Bai-salam is essentially a forward agreement where delivery occurs at a future date in
exchange for spot payment of price. Unlike earlier mechanisms of bai muajjal and ijara,
salam or salaf was originally designed as a pre-cultivation financing mechanismfor small
farmers. Under a salam agreement, a farmer in need of short-term funds sells its output in
advance to the IsMFI on a deferred delivery basis. It receives full price of the farm output
on the spot that serves its pre-cultivation financing needs. At a pre-agreed future date, it
delivers the output to the IsMFI. The IsMFI then sells the output in the market at the
prevailing price. Since the spot price that the IsMFI pays is pegged lower than the
expected future price, the transaction should result in a profit for the IsMFI.
Thus, under salam the farmers would receive the price of their produce in advance at
the beginning of agricultural season against an obligation to deliver a defined quantity
of the produce to the buyer after a definite time period in future (after harvest). The sale
price received in advance is available to the farmer as a means of financing all farming
related needs. Another advantage is that the farmers do not have to sell their produce
at a time when the market has an oversupply due to harvest, thus depressing the prices
and bringing down the realized income of farmers. While the mechanism provides for
much needed financing, it is subject to abuse by unscrupulous intermediaries and traders
who seek to take advantage of low bargaining power of the poverty-ridden farmers and
execute salam at unrealistically low prices. To counter this, mutuality-based models of
microfinance have been suggested. Farmers’ cooperative organizations can dramatically
enhance the bargaining power of farmers and replace intermediaries. In a salam-based
framework, these cooperatives would provide funds in the form of advance price and
would take delivery of the produce after harvest as above. The cooperative would also
create appropriate warehousing facilities for storage of the produce and market the same
in a manner that avoids depressed prices resulting in increased income for the members.
The Jeddah-based Islamic Development Bankmay be credited with pioneering this model
successfully. The model involves creating cooperatives (mudarabas) of farmers, and
placing funds with them for salam financing to member farmers as well as providing
other non-financial services relating to warehousing, processing, packaging and
marketing services in a few of its member countries, such as, Guinea and Palestine[13].
Another problem with classical salam for the financier arises out of its exposure to
price risk or market risk. A financier who is not an astute player in the market for the
concerned commodity and does not fully understand the economics of pricing in this
market may be confronted with adverse prices and consequent losses when it seeks to
sell the produce upon delivery by the farmer(s). This problem may be taken care of in
several ways. First, a back-to-back salam under which the IsMFI enters into a parallel
salam with a market vendor (say, a miller) and locks a forward price mitigates their price
risk. Once the farmer delivers the output to the IsMFI, the same in turn is delivered to
the vendor. The difference between the two advance prices is pre-determined profit for
the IsMFI. Second, a variant of bai salamcalled value-based salamis specifically designed
to mitigate price risk. This may be explained with the following example.
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In a classical salam, the quantity of object of sale (agricultural produce) and the price
per unit of the object of sale are pre-determined at the time of contracting. If Q amount
of paddy is sold on forward basis at price P on salam basis, then the financier (buyer)
would pay the value of transaction PQ to the farmer (seller) at the time of contracting
(before commencement of farming). After a defined and known time period (harvest
time), the farmer would deliver Q amount of paddy to the financier. The financier in
turn, would find a way to dispose of Q amount of paddy in the market at the prevailing
market price P*. If market price increases during the financing period, P* would be
higher than P. In other words, P*Q would be higher than PQ and the financier would
have positive profits (P*Q−PQ). If however (and this is quite likely given the abundant
supply of produce during harvesting season) the prevailing market price is depressed
and P* is lower than P, the financier would end up with losses. The value of P*Q−PQ
would be negative. This market risk or price risk is mitigated in case of a value-based
salam. In the latter type of salam, the MFI would pay an amount (say V) to the farmers’
cooperative at the time of the contract against an obligation of the farmer to repay in
physical quantities of its produce whose value at the time of delivery at a future
date (after harvest) is pre-determined (say V*). In other words, the farmer would deliver
V*/P1 quantity of paddy to the MFI if the future price at the time of delivery is P1 and
V*/P2 quantity of paddy if the future price is P2 and V*/P* quantity of paddy if the
future price is P*. This settlement value (V*) may indeed be pegged higher than the
original value (V) received in advance by the farmer resulting in a known profit (V*−V)
to the financier. While this form of contracting is not well known, Obaidullah and
Saleem (2011) presents a case study involving its application in Sri Lanka. The case
study documents the case of Muslim Aid (MA) Sri Lanka seeking to take care of the
safety needs of the poor farmers, to build a sustainable source of funds for them as
a cooperative organization and to free them from exploitation by trader-middlemen by
intervention through the market mechanism. MA also sought to create a win-win
situation for the trader-middlemen by forming a partnership with them.
MA used a multi-stage model for provision of finance and other inputs to the
farmers. The first stage involves a creative variant of the classical bai-salam or
“deferred delivery” transaction. Under this mechanism, a farmer was provided funds
in advance against a forward sale of his produce at the time of harvest. The funds were
used by the farmer to finance purchase of the necessary inputs to start paddy
cultivation. Unlike bank financings, no collateral was required from the farmer. Instead,
a farmer needed to obtain a set of recommendations from the local mosque and
community leaders who acted as guarantors. The second stage began at harvest time
once the agricultural produce was delivered to MA. It involved a partnership between
MA and local miller(s) to take possession of the harvested paddy from the farmers,
process it and sell the final product at the market with the profit being shared between
MA and the miller(s) on the basis of a mudharabah partnership. It was expected
that the profit share of MA would cover the administration cost of the financing.
In order to ensure that the over-all model was a not-for-profit one and that it was also
sustainable one, any surplus of profit share over administrative cost was to be used to
create a Revolving Fund for the farmers (see Figure 1). Farmers enjoying incremental
income were also expected to make zakah contributions to this Fund and therefore,
adding to its size and ability to provide financing to greater numbers. This was the
third stage of the model[14].
The modes discussed above, involve credit and may be used by an IsMFI as
Shariah-compliant modes of extending micro-credit to farmers. A major problem
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associated with such modes relates to the possibility of willful default by clients. Unlike
conventional microfinance where defaults may result in additional interest payments
and/or rescheduling of loan, and where prepayment may result in rebates, Islamic
modes do not admit the possibility of any payment in excess of the original amount of
debt. Islamic scholars generally permit the IsMFI to impose a penalty on the defaulting
client to act as a deterrent against willful default, but such penalty must be donated to
a charity. It cannot be treated as an earned income for the IsMFI as this would
tantamount to riba. Such income is indeed reported in the financial statement of IsMFIs
as “non-halal” or impermissible income that must be donated.
2.4 Mudaraba-musharaka (trustee partnership-joint venture)
IsMFI may also consider various partnership based modes or equity-based modes for
financing poor farmers. Two classical modes commonly discussed in this context are
mudaraba and musharaka. We also discuss a novel concept of declining musharaka
leading to complete ownership of asset or project by the farmer. These equity-based
products are unique to Islamic rural finance and in some sense, account for its superiority
over its conventional counterpart on grounds of ethics and efficiency. Arguably, because
of their uniqueness, they are also less commonplace.
A mudaraba also known as trustee-partnership is a mode of finance through which
the IsMFI provides capital finance for a specific agri-venture initiated by the farmer.
The IsMFI, called rabb-al-mal is the owner of the capital and the farmer, called mudarib,
is responsible for the management of the agri-venture. Profit is shared according to
a pre-agreed ratio. Losses if any are entirely absorbed by the capital provider – the
IsMFI. Mudaraba may be of two types – restricted or unrestricted. In a restricted
mudaraba (mudaraba al-muqayyada), the IsMFI may specify a particular business
in which investments may be undertaken. Mudaraba may also be an unrestricted one
(mudaraba al-mutlaqa); in which case the mudarib may invest the capital provided in
any venture (s)he deems fit.
A musharaka or a joint venture involves a partnership in which both the IsMFI and
the farmer contribute to entrepreneurship and capital. It is an agreement whereby the
farmer and the IsMFI agree to combine financial resources to undertake a venture, and
agree to manage the venture according to the terms of the agreement. Profits are shared
between the IsMFI and the farmer in the pre-agreed ratio. Losses are shared strictly in
proportion to their respective capital contributions.
A variant of musharaka that has traditionally been used in Muslim societies for
agriculture is muzara’a or output sharing. This mode allows the owners of inputs for
Salam (Value-Based) Mudaraba
Money to
farmers as
price in
advance
Repayment in
paddy plus
zakah
Process
paddy and sell
in market at
profit
Recover
admin cost +
profit +
capital
5 Months 5 Months
Profit Figure 1.
Overview of
MA model
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agriculture, e.g. land and labor to come together and undertake cultivation. The
output post-harvest is shared between the land owner and the laborer (landless farmer)
as per a pre-agreed ratio. Another variant known as musaqa is a contract between the
owner of an orchard (of fruits or vegetables) and a farmer who can irrigate and look
after the orchard. The output of the orchard is shared between the parties as per a
pre-agreed ratio.
An interesting project (supported by the Islamic Development Bank) to help poor
olive farmers in Palestine involves use of a composite model. The IsMFI is involved in
each step of the olive value chain. First, it facilitates a muzara’a agreement between
the landowners and the poor farmers. It provides salam financing for olive seeds
and fertilizers. The olive harvest collected by IsMFI is sold to olive oil mills for a profit.
The uniqueness of this model as compared to conventional model is as follows. In the
event of loss due to crop failure: the landowners would lose potential income under
profit-sharing; the farmers would have to pay back (cash or in kind) to the IsMFI
no more than the advance payment and the IsMFI would lose potential profit from sale
of olives to oil mills. Under the conventional model, however, a different set of outcomes
would be in place in case of crop failure. The farmers would have to pay rentals due
to landowners; principal loan due to MFI; and interest due to MFI. In short the poor
farmers would have to bear the entire downside risk with agriculture.
Another variant of musharaka called diminishing musharaka has great potential
for the IsMFI as a financing product. While a classical musharaka aims to involve
the IsMFI as a permanent partner in the venture, in a declining musharaka, the IsMFI’s
share in the equity is diminished each year through partial return of capital. The IsMFI
receives periodic profits based on its reduced equity share that remains invested during
the period. The share of the farmer in the capital steadily increases over time, ultimately
resulting in complete ownership of the venture.
Agency problems with partnership-based modes in Islamic finance are cited as the
key reason behind preference of mainstream Islamic financial institutions (IsFIs) for
debt-based products. The problems – for example, when the mudarib or the trusteemanager
may act in a manner that is not in the best interests of the capital-providers –
become particularly acute in informal and rural settings. A few other problems that are
usually cited with partnership-based modes as compared to sale and lease based modes
are as follows: One, partnership-based mechanisms require long-term involvement by
the microfinance institutions in the form of technical/ business assistance, which raises
the cost of implementation. Two, the uncertainty about profits is a major drawback of
such modes. Although microfinance programs have information on local market
behavior, weekly profits fluctuate. Fluctuating profits make it extremely difficult for
institutions to predict their cash flows. Farmers can make the job doubly difficult by
not keeping accurate accounts. Three, the partnership-based modes are difficult to
understand for IsMFI officers and borrowers alike. Even in the hypothetical situation
that profits were known, the borrower has to repay a different amount each period (and
the officer has to collect a different amount each period). This lack of simplicity relative
to equal repayment installments is a source of confusion for borrower-farmers and
IsMFI officials. Unlike profit-sharing mechanisms, bai muajjal does not require the
farmer to maintain written records that are often unavailable at the rural enterprise
level or if available, the farmer may be unwilling to share them.
While IsMFIs may use some or all of the above for-profit modes in the interest of
sustainability, their mission driven approach of helping the rural poor requires
provision of a mix of financial and non-financial services that include handholding and
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other forms of support to farmers. The overall objective is benevolence-driven and
often strictly not-for-profit. Indeed, Islamic economics and finance provide a range of
benevolence-driven, philanthropy-based and not-for-profit mechanisms as well, whose
importance can be hardly overemphasized, especially when seeking to address the
financing needs of the poor farmers.
2.5 Qard al-hasan (interest-free loan)
Qard hasan literally means a beautiful loan. It is a loan granted by the lender without
expectation of any return on the principal. Islam provides very strong incentives for
lenders to meet the financial requirements of the needy by providing loans without
expecting any gain in return from them. Any such return expected or demanded by the
lender is forbidden riba. It is pertinent to note several things here. First, the lender is
permitted to recover the actual cost it incurs in the process from the beneficiary or the
borrower. However, the amount charged to borrower must not be more than the actual
cost of operation. Thus charging the borrower based on notional or estimated cost of
operation is ruled out. Two, Islam exhorts a borrower to be generous when (s)he repays.
(S)he is allowed and indeed, encouraged to return more than (s)he originally borrowed
from the lender. The excess is viewed as a gift (heba) from the borrower and is
permissible as long as it is not demanded (stipulated in the contract) by the lender.
A Muslim is also encouraged to avoid debt. (S)he should strive to get out of debt if (s)he
is already trapped in it. (S)he must make all efforts to repay the loan as early as
possible. At the same time, Islam encourages a lender to give extension in time or waive
part of the loan, should the borrower be forced to default. It completely rules out any
penalty for default that is unintentional. However, in case of willful default or
delinquencies, a penalty may be imposed as a deterrent. Such penalty, once collected,
must be donated to charity and cannot form part of the income of the lender. At an
institutional level, one finds that this mode forms the basis of over 6,000 Qard al-Hasan
Funds (QHFs) dotted across Iran, which provide microfinance primarily to the rural
poor[15]. The QHFs raise funds using the qard al-hasan mode from their depositors;
and lend onwards also using the same mode. Another interesting application of this
mode on the lending side only (funds are raised through charity) is the Akhuwat model
in Pakistan[16].
2.6 Sadaqa, zakat and waqf (charities and endowments)
The broad term for charity and philanthropy in Islam is sadaqa. Sadaqa is in the nature
of free donation without any strings attached. When compulsorily mandated on an
eligible Muslim, sadaqa is called zakat. When sadaqa results in flow of benefits that are
expected to be stable and permanent (such as, through endowment of a physical
property), it is called sadaqa jariya or waqf.
Zakat is an institution of philanthropy mandated by faith. It may also be seen as a
compulsory levy on every believing and practicing high-net-worth Muslim. From
a macroeconomic perspective, zakat is a source of recurring annual flow of funds. Since
Islamic law restricts the allocation of zakat funds to eligible beneciaries alone, that
primarily include the poor and the needy, zakat is potentially a major tool of poverty
alleviation. It is more in the nature of a safety net to take care of the basic necessities
of life of poor farmers who cannot afford them. Additionally, zakat funds can be used
in a variety of ways for the farmers; for skill enhancement, provision of start-up capital,
or pay off the debt of the over-indebted farmers as long as the beneficiaries suffer from
abject poverty.
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Waqf, which essentially implies the irreversible endowment of an asset of value
(e.g. real estate, cash) by a donor with a stipulation that the returns generated through
investment of the asset or the benefits flowing out of the asset are used for specified
purposes. Thus waqf, by definition, provides for a sustainable source of funds/ benefits
that may be targeted at the poor farmers.
To sum up, Islamic finance provides a fairly broad range of modes and mechanisms
that may be used for provision of financial and non-financial services and support to
the poor farmers. Often some or all of these charity-based, not-for-profit and for-profit
mechanisms are combined in models to provide holistic solutions to the problems of the
poor farmers, alleviate their poverty and help them enhance food security. In the next
three sections, we discuss some composite models of intervention that are recent and
deemed highly successful by observers.
3. Farmers’ empowerment program (Indonesia)
DDR is a pioneer in using Islamic philanthropic funds, such as, zakat, sadaqa and cash
waqf for alleviating poverty. The program for economic and social empowerment of
farmers by this leading non-government organization[17] in Indonesia seeks to provide
a solution to the multiple problems of limited land, declining soil fertility, high input
prices, limited capital, low and limited farming skills, unremunerative and fluctuating
crop prices. It has embarked on an organic farmers’ empowerment program called
Pemberdayaan Pertanian Sehat (P3S) that adopts a holistic approach involving
adjustment of cropping patterns and change in farmers’ attitude and preferences from
conventional farming to a semi-organic cultivation system. The intervention involves
gradual and continuous assistance, guidance and introduction to production facilities
that are safe, locally made and affordable, to biotech and low-chemicals system through
integrated and environment-friendly farming. The semi-organic cultivation system
reduces farmers’ permanent dependency on chemical agricultural inputs that are
expensive. With the user-friendly green agricultural technology, farmers can reduce
production costs while obtaining higher prices for the organic produce.
The organic farmers empowerment program (P3S) involves provision of farmland
on ijara (lease) and of capital for semi-organic farming with a view to bringing about
significant increase in farmers’ earnings. The empowerment process also involves
strengthening of farmers’ capacity as human resources and helping them get organized
as formal communities, called combined farmers groups (gapoktan). The intervention
ends when the combined farmers groups have developed the capacity to manage the
formal organization independently, putting in place partnerships with other
stakeholders to support the organization’s existence, and improved their bargaining
position in the market.
Farmers’ eligibility for P3S program is based on several criteria, e.g. income and
ownership, business potential and the farmers’ potential as human resources. The main
target group are poor farmers meeting the following criteria. The farmers’ family head
earns ⩽ two USD per day in rural areas, or ⩽three USD per day in sub urban areas.
The other criteria relate to condition of their house and ownership of assets. Approval
from local neighborhood based on the defined criteria is needed to confirm a poor
family’s eligibility for the program. The business potential criteria include: the
development potential, which reflects the ability to expand the business in scale and
scope, related to the raw materials availability, production capacity, market potency
and employment rate; the potential to create derivative businesses that allows more
employments and economic benefits for other beneficiaries; and the potential for local
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resources utilization. Besides the above, a farmer must be of minimum productive age
of 18 years or is married, with maximum age of 60 years; should have the vision for
developing business; should be able to work; and should not be enlisted as participant
of any other similar program.
3.1 Components of the program[18]
The empowerment program involves several stages. Stage 1 involves promoting
awareness or recognition of potential and the environment followed by building
comprehension that organization in the center-stage of this process must be started
with the community’s initiative through continuous strengthening of the organization.
The programs then aims to prepare a cadre of local farmers who would take over the
task of mentoring after the program ends; to provide technical support, associated to
the technical aspects of the production process, which includes the introduction and
implementation of organic farming technology and semi-organic farming, adaptation of
technology, development of pre-and post-harvest processes as well as access to
information. It seeks to assist the farmers in fulfilling their needs, both individually and
in groups, in a sustainable livelihood system. The overall objective is to maintain
a balance in the interests of all the stakeholders by enhancing the bargaining power of
farmers through their own cooperation-based institution.
The process of forming farmers’ organization involves the following stages. First,
individual farmers in groups of eight to ten form small groups. Next, several groups are
organized into a secondary group called a combined farmers’ group called gapoktan[19].
Finally, several gapoktans are combined to form the farmers’ cooperative.
Since a major problem for farmers is the lack of land ownership, one of the
components of the P3S program is the provision of leased land to farmers.
Once farmers groups are formed, the next stage is the leasing of land to each farmer at
an average land area of 25,000 m2 for each farmer or 2.5 hectares (six acres) for each
group. Farmers get lease land for one year with the rental fee of Rp 4,000.000 (USD 150)
per hectare per annum. In addition to the land lease package, farmers also receive
a package in the form of processing costs of land, direct costs of labor for one growing
season. Farmers are expected to use the organic agricultural inputs (saprotan) and
working capital funds of the enterprise. Labor fees are directly paid for the overall
processes of land production and harvest. Assistance is also provided in the form of
fertilizer, compost, plant pesticides, seeds, etc. The program through research has
developed its own organic agricultural input (saprotan) in the form of bio pesticide that
is local-based, affordable and environment friendly.
A major component of the empowerment program is institutional capacity-building.
Assistance for the strengthening of the institutional groups of farmers and farmer
groups (gapoktan) involves the following. Enhancing the capacity of farmers is done
through various forms of training in semi-organic agriculture as also in organizational
and financial management of farm groups and gapoktan administrators, establishment
of the gapoktan forum, as well as periodic monitoring and linking up to other
stakeholders and the market. For instance, during the process of cultivation of rice,
the tutoring process, both regular and irregular meetings, is done through visits to the
homes of the farmers. Tutoring is done through regular meetings of the Group once
a week. The process of transfer of appropriate technology and organic rice cultivation
is delivered through group meetings. An example of the move towards self-sufficiency
is a consensus made among farmers that each farmer must save up to 40 percent of
their harvest, which would initially be used to pay land lease for the following year.
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3.2 Zakat-funded programs
The organic farmers empowerment program (P3S) along with other economic
empowerment programs of DDR is funded with zakat. The funds dedicated to such
programs average about IDR 6.3 billion per year over the five-year period (2008-2012)
that hovers around 10 percent of total zakat resources available (see Table I). The low
dedication is attributable to apparent Shariah objections by some scholars who
emphasize on utilization of zakat for consumption alone in the short term. In the face of
a growing realization, however, that an emphasis on short-term may lead to a
dependency syndrome among the poor, and that the long term need of the poor is
economic and social self-reliance, DDR seeks to enhance the utilization of zakat for
community empowerment programs.
Among the major economic programs of DDR are: the masyarakat mandiri
(self-reliant communities), pertanian sehat (health/ organic farming), kampoeng
ternak nusantara (livestock development), Islamic microfinance (for-profit) in
addition to capacity building initiatives under Indonesia Magnificence Zakat. The
economic empowerment programs follow a similar model that involves interest-free
loan financing to groups from a pool created out of zakat funds. The key
distinguishing factor of this model is the phased building of self-reliant communities
and the creation of a community organization that would continue to provide
financing to the members.
The program has a clear termination and exit strategy. It withdraws from the region
and the program ends as soon as the community cadres are ready to take part in
maintaining program sustainability – financial and institutional. It ensures that a
community-based organization is a legal entity with adequate capacity to sustain
cooperation with all stakeholders. From a Shariah perspective, this ensures that the
“tamleek” condition of zakat is complied with, since the poor beneficiaries ultimately
become the owners of the local organization in a collective sense with transfer of assets
from the program to the local organization. Thus, the fact that they are borrowers in
the first instance does not appear to vitiate the “tamleek” requirement[20].
4. Credit and lease-based finance (Pakistan)
According to a survey by a group of researchers from Lahore University of Agriculture [21],
there are about 5.1 million farms in Pakistan. Of this, 93 percent are small and
marginal accounting for 60 percent of the total cultivated area. They also found that
about 70 percent of farmers participate in the credit market; a majority from
intermediaries charging exorbitant interest rates. Further, the farmers also believe that
they can save up to 25 percent in costs if they purchase inputs on cash. In addition,
given that farmers usually return the money after the sale of the crop, the study argues
that banks should participate in agricultural sector using bai salam as the mode of
No. Field program Program Funds (Rp billion) Beneficiaries
1. Organic farming 15 4.6 2,611
2. Livestock 9 6 997
3. Fisheries 52 11.1 6,175
4. For-profit microfinance 6 4.3 2,186
5. Research, in house and public training 150 5.6 5,164
Total 232 31.7 17,133
Table I.
Five-year details
on economic
empowerment
programs by DDR
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finance. A similar reasoning seems to underlie the design and development of salam
as an agri-finance product by Wasil Foundation, a leading Islamic microfinance
provider in Pakistan.
Wasil Foundation, formerly known as Centre for Women Co-Operative Development
(CWCD), is a not-for-profit company established in 1992. The aim of the organization is
to economically empower poor communities and assist them in developing their
businesses through micro credit and enterprise development programs. In 2009, Wasil
Foundation (formerly CWCD) extended its operations from conventional microfinance
to Islamic microfinance. Eventually, it discontinued conventional microfinance in 2010,
thus becoming a purely Islamic microfinance organization. The pioneering efforts of
Wasil Foundation in meeting the financing needs of different strata among the urban
and rural poor has resulted in a diverse range of products in its portfolio (see Table II).
Thus, Wasil has three products specifically targeted at the farming community. It
believes that farmers in Pakistan are traditionally skilled but lack capital. Its first
product based on bai salam is targeted at small farmers with up to five acre land
holding, who need money to grow their crops and to feed their families up to the time of
harvest. Under the salam agreement, Wasil makes payment of agreed price in advance
to the farmer against commitment to deliver agreed quantity of produce upon harvest.
It involves lower cost as compared to other alternatives and finance is provided against
a collateral in the shape of guarantee from community members or a charge on
available assets with the farmer, e.g. livestock. Wasil’s second product seeks to address
the issue of lack of land ownership among farmers through leasing. Wasil takes
agriculture land on ijara from the owners of the land in bulk and sub-leases the same to
farmers for agreed period in exchange of pre-determined monthly lease rentals. In case
of fruits/vegetable/flower farms the lease rental is paid in cash. In the case of wheat and
rice, the lease rental is paid in kind in the form of crops.
Wasil’s third product combines the concepts of ijara and salam and bases the whole
return on the principles of salam, which requires settlement of debt in terms of the
crops or produce. Under this agreement called Master salam, the farmer gets land on
rental plus cash as working capital to cover related costs and agrees to deliver a given
quantity of the crop to Wasil. A part of the repayment in terms of crop is towards
rentals on ijara while another part relates to salam. After the first cycle of finance, there
are two subsequent cycles of financing that are based on salam alone. After the two
additional salam cycles, the contract ends.
4.1 Risk factors and their mitigation
The main challenge concerning the salam transaction is the identification of the quality
of the crop and the determination of the price at which it must be procured. The
Government of Pakistan issues a support price for wheat at which the Food
Mode Target beneficiary
Zakat Destitute unable to work
Qard al-hasan Poorest of the poor with ability to work
Murabaha Micro level traders street hawker Small shopkeepers
Salam Small farmers up to 5 acre land holding
Ijara Farmers without land holding (rental land)
Diminishing Musharaka Micro entrepreneur in need of assets
Master Salam (Ijara + Salam) Developed by CWCD farmers in need of land plus money for cultivation
Table II.
Islamic finance
products by Wasil
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Department of Government of Pakistan procures it. However, when Wasil Foundation
approached these departments for the sale of crop, they refused due to the restriction
levied upon them by the Government of Pakistan whereby only a farmer may sell to
these departments. Thus, the only other options were the sale to the flourmills or to the
open market. Furthermore, unlike the support price at which the Government
purchases the crop, the flourmills and the open market rates are determined by certain
market factors including the quantity of national produce.
In order to determine the price, Wasil Foundation takes the data of the sale price in
a specific area over the last three years. This gives a rough estimate of what the price
is likely to be for the crop that is to be grown. Wasil Foundation then offers a float rate
at which the purchase price is negotiated with the farmer/client. This negotiation takes
place at the village level with groups of farmers who are likely to sell the crop to Wasil
Foundation. At the end of this negotiation, Wasil foundation determines a final price
at which it procures the crop. At times, this price may vary from area to area based on
the cost of production, the expected yield, the sale price of the area in the last years
and the amount of risk that the organization has to face.
In June of 2010, Wasil Foundation launched its first rice salam transaction. Unlike
wheat, the market rate of rice crop is entirely dependent on the quality of the crop
wherein the seed of the crop is of major importance. In the case of wheat, the seed being
planted does not directly affect the price, as the output crop is the same. In case of
rice crops, these are categorized in accordance to the seed that is being planted by the
farmer. Thus, the challenge of the quality of the crop and the proper identification
of the seed is of vital importance while conducting a salam transaction on rice. For
this, Wasil Foundation trained its procurement and sales department, through the
agriculture department of Government of Punjab, Pakistan, on the types of rice and
the identification techniques of rice.
Unlike wheat, there is no support price by the Government for rice, which makes
the estimation of the purchase price more complex for rice. The options open for
Wasil Foundation are again, as in the case of wheat, the selling of the crop to the open
market or the rice mills in the area. However, unlike wheat, when rice is harvested, it
contains a high moisture content due to which the total weight of rice is increased
by approximately 15-20 percent. This moisture further induces a chance for the crop
to be damaged if it is not dried up in time. These issues increase the risk of holding rice
at a warehouse for collection and sales purposes. Thus, unlike wheat, which may be
stored for up to three months by Wasil Foundation, rice is to be sold within a maximum
of one-month period due to the unavailability of the proper infrastructure to store rice.
This challenge still exists while conducting a rice transaction of salam.
The crux of the Master-salam product is the repayment in the form of crop rather
than cash. This makes enormous sense, given that the client/farmer is not rich in cash
during his crop cycles, which makes it difficult for the farmer to make the monthly
repayment in cash. However, the farmer/client is rich in crop at the time of harvesting.
Therefore, the product is focused on the principles of salam wherein the crop is delivered
as a repayment for cash inputs, plus for the extra input of land in the form of ijara.
5. Composite partnerships with farmers (Sudan)
A model that has been experimented in Sudan in the recent past adopts a composite
finance-plus approach to support the farming communities.While there are elements of
credit-based financing, the overall models are rooted in partnership. The underlying
rationale for this approach seems to be the pivotal role that the IsFIs see for themselves
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in addressing various problems of the poor farmers and in enhancing food security of
the region. While agriculture in Sudan faces problems similar to those in Indonesia
and Pakistan, the challenges here are even greater arising out of adverse weather
conditions, large tracts of drought-affected land and civil strife leading to a faltering
economy riddled with unemployment. Islamic microfinance in Sudan, however, has a
lot to offer in terms of its uniqueness and high success rate.
The microfinance program of BoK, known as IRADA, is experimenting with new
and innovative models of intervention to make inroads on chronic social problems, such
as, poverty and unemployment. As part of the Sudanese economic system, it operates as
a Shariah compliant bank. At the same time, it uses participatory modes within a model
that is rooted in cooperation to create and share wealth in the agriculture sector[22].
BoK was established in 2002 while its microfinance program (IRADA) was established
in 2009 with the support and assistance from the Islamic Development Bank. The
department was given the mandate to implement the SDG 200 million Al-Aman fund
for microfinance. The fund was formed by a strategic partnership between the Diwan
Zakah (apex body of zakat management in Sudan) and 32 Sudanese commercial banks.
IRADA was set up with a vision “to alleviate poverty and hunger by realizing the
potential of the poor through development of limited resources and affordable
financial facilities,” and a mission “to increase the numbers of poor people involved in
entrepreneurial activities through Islamic finance and expanding income generating
activities, creating sustainable livelihood and employment.” Its programs and
activities are influenced by its strategic approach theme, which states, “Today the poor
are our clients, but tomorrow they will be our business partners.” Since inception,
IRADA identified and focused on “economic empowerment through group finance
and partnership.”
5.1 Innovative use of zakat
In perhaps the first documented example of utilization of zakat for gharimeen (indebted)
in an organized manner, globally speaking, a security portfolio was created through a
partnership between the Diwan Zakah (apex body for zakat management in Sudan) and
commercial banks. The portfolio has a capital of 200 million pounds with 25 percent
contributed by the former and the balance by the banks. The portfolio provides an
insurance to the program against genuine defaults by clients at the second level. At the
first level, the default is covered by individual personal guarantor(s) brought in by the
client. The portfolio covers all productive sectors (commercial, agricultural and
vocational) across Sudan.
5.2 Business development services
IRADA has carefully developed a network of providers of business development
services on its payroll to provide a range of additional services to its clients. In many
ways, these officers are key to the overall success of the program with their ability to
source and procure the assets needed for the income-generating microenterprises and
their role in monitoring the clients. In fact, each client is assigned a business
development officer who is responsible for ensuring that the relevant asset is delivered
to client, that the supplier is paid, and that the client makes timely repayment to the
bank. The business development officers are also entrusted with the task of advising
the clients on how their business can be more profitable. They also use their network in
order to facilitate mutual exchange among their clients. The provision of business
development service is adequately incentivized.
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5.3 Abu-Halima Greenhouses Project
The Abu-Halima Greenhouses Project of IRADA, designed in 2011, uses a composite
model of intervention that combines several “smart” factors and is designed to address
several critical social issues including lack of food security, unemployment and
poverty. It aims to open new economic opportunities for young university graduates
with formal education in agriculture. The project in its current phase, targets economic
empowerment of 125 educated unemployed graduates and their families. The project
involves setting up 25 productive units of greenhouses with annual capacity
production of 1,200 tons of off-season vegetables using latest technology in the
industry and professional expertise using the partnership-based mode.
The business plan of the project is rooted in the economic peculiarities of the local
market for vegetables, which witnesses a major spurt in the vegetable prices because
of adverse weather conditions. The greenhouses would enable the micro-entrepreneurs
to grow high-value vegetables all through the year, while smoothening the supply
of vegetables in the Khartoum market. The greenhouses can now grow vegetables that
usually witness many-fold price rise during summer and other high-value vegetables
during winter, thus, reducing price volatility. The underlying model for the project
is presented in Figure 2.
The model (restricted mudaraba partnership). Unlike the regular micro-credit
products, or even the commercial mudaraba products, the partnership between the
bank and the micro-entrepreneurs extends well beyond that of a creditor and debtor or
that of a rabb-al-maal (fund provider) and mudarib (fund manager). The bank assumes
Min. of Finance IRADA – BoK
Abu Halima
Min. of Social Affairs Graduates
Min. of Agriculture
Tech Consultant
Sana Hypermarket
1
2
3
5
7
6
8
9
10
4
Notes: Arrows denote specific activities as follows: (1) financial partnership
between Ministry of Finance and BoK; (2) nomination of agriculture graduates for
the project by Ministry of Social Affairs; (3) Mudaraba agreement between
IRADA (BoK) and the micro entrepreneurs (agriculture graduates); (4) setting up
of Abu Halima greenhouses; (5) technical consultancy to micro entrepreneurs;
(6) technical consultancy to greenhouse establishment and operation;
(7) provision of fertilizers and other services by Ministry of Agriculture; (8) sale
of vegetables output to Sana Hypermarket and others; (9) sharing of profits
(40 percent for five years and 100 percent after that) by micro entrepreneurs; and
(10) sharing of profits (60 percent) by IRADA-BoK for five years
Figure 2.
The Abu Halima
Project
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responsibility for provision of financial as well as a range of non-financial services to
the micro-entrepreneur in the form of technical, marketing and business development
services. The latter involves direct investment in creation of assets for supply of
electricity, water as well as for vegetable cooling, storage and other services.
A beneficiary of this project must come from low-income strata of the Sudanese
society and the income of the household should not exceed two times the minimum wage
of USD 207 per month according to the law of Central Bank of Sudan. The beneficiaries
are organized into jointly liable groups of households (headed by graduates, preferably in
agriculture) in the form of a cooperative society registered according to the Sudanese
Cooperative Law. These groups enter into the restricted mudaraba partnership contract
with BoK. The micro-entrepreneurs receive the required technical training from experts,
managerial and marketing support from the bank. They are eventually organized into a
co-operative, which allows them to benefit from common facilities while retaining their
right to do business activities.
Other stakeholders and partners in the project include: Ministry of Finance, which has
made a social contribution of 6.5 percent of capital; the State Ministry of Agriculture,
which helps get fertilizers and assists in technical capacity building; the Ministry of
Social Affairs, which nominates the beneficiaries through its Graduate Fund; and Sanaa
food hypermart and home center – a major supermarket chain – which has committed to
off-take the vegetables. A technical Turkish firm, specializing in the technical aspects of
greenhouse projects is a significant contributor to the success of the project.
Financing method. The financing product is structured using the mudaraba mode
with profit and loss features. Losses would be absorbed by the bank while profits
would be shared in the ratio of 40 percent for the micro-entrepreneur and 60 percent for
the bank. Profit distribution would take place twice in a year. The “restricted”
mudaraba involves total financing to the tune of SDG 15 million (USD 4.50 million),
which accounts for about 6 percent of the total portfolio of IRADA. It involves
financing of working capital to purchase the 25 greenhouses, supporting infrastructure,
technical feasibility, technical capacity building, agricultural inputs and living
allowances. As stated above, the Ministry of Finance has contributed 6.5 percent of
mudaraba capital as a social contribution with a view to lower the costs borne by the
beneficiaries.
IRADA’s product package includes the services of an administrative coordinator,
and an agricultural expert to supervise the production process and technical matters,
ensure quality control and providing training. Such costs are included with the direct
cost of the product. IRADA would retain control of the venture for five years,
essentially to ensure its profitable operation. During this implementation period of five
years, the graduate micro-entrepreneurs would be trained to manage the ventures.
IRADA would cede control of the project assets to the cooperative as a gift or sale at a
nominal price after five years. Depreciation of assets is calculated at 20 percent per year
over five years. The only collateral that the bank would be seeking for this financing is
a personal guarantee against mismanagement and lack of commitment. There are no
financial or physical collaterals required. However, the households, through the
cooperative society, are required to submit a check as a security for default and
infringement. The title of the assets is in the name of BoK as the rab-al-mal during the
finance term, thereby, mitigating the asset-related risks. BoK, being the provider of the
funds (rab al mal ), has an insurance contract with the Islamic Insurance Company to
cover the assets against any loss.
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The returns on investment to IRADA would come in the form of 60 percent of
profits made on the sale of 1,200 tons of high value vegetables and fruits annually. This
is expected to generate an ROA of 18 percent and IRR of 22 percent for the bank.
Returns to the micro entrepreneurs would come in the form of balance profit share,
estimated at SDG 2,100 per family plus an additional living allowance of SDG 300-600
per family during the implementation period. The returns are expected to significantly
increase to SDG 7,000 per family, since IRADA would withdraw after this period and
the micro entrepreneur would receive full profit share.
A unique feature of the design of this microfinance model is the safety net during the
implementation period of five years. This makes enormous sense as the mudaraba
profits may display volatility while the basic needs of the micro entrepreneurs must be
taken care of on a priority basis.
Non-financing services. Another unique feature of this project is the magnitude and
variety in the provision of a multitude of non-financing intervention/ services to the
micro entrepreneurs. These may be listed as under: assistance to source and hire
technical firm to construct greenhouses and related infrastructure and to provide
technical support throughout project lifetime; pre-production support in the form of
seeds, fertilizers, pesticides, machineries, electric and water sources; at-production
support in the form of living expenses allowance, operational expenses, harvest
expenses, technical support; after-production support in the form of cooling storage
and grading room; assistance to source large customers such as DAL and Home Centre
to purchase produce; assistance to manage the project accounts; formation and
registration of cooperative of farmers; and transfer of ownership to the cooperative
upon its readiness to manage the business.
Risk management. An agri-venture like Abu Halima faces several risk factors,
many of which may lead to crop failure and consequently to failure of the project.
The success of the project hinges on mitigating these risks. Below we list some
major risk factors identified by BoK and the various measures contemplated to
address them:
• Inability to sell produce: contractual agreement with major customer(s) is in place
to purchase products at market price.
• Crop failure due to disease: program has provided the micro entrepreneurs
with fertilizers and ensured that they have the capacity to use appropriate
amounts.
• Crop failure due to heat: greenhouses have automatic temperature control.
• Crop failure due to lack of humidity: greenhouses have automatic humidity
control.
• Crop failure due to lack of water: drip irrigation system is developed to provide
water. Well is constructed to provide sufficient water.
• Electricity blackouts: program has provided generators that run on diesel to
function as backup electricity.
• Unmet consumption needs leading to a lack of commitment: families are provided
SDG 300-SDG 600 as living allowance every month all through the five-year
implementation period.
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• Lack of commitment by beneficiaries: BoK has retained an option to remove a
given beneficiary and replace them with another. Beneficiaries have to sign into
work and their performance is monitored. Bank has the prerogative to distribute
a larger proportion of profits based on performance and commitment.
• Conflict during distribution of profits due to different yields: profits of the micro
entrepreneurs and bank is based on the total production of all the greenhouses
and not on an individual greenhouse basis.
Challenges. Notwithstanding the apparent success of the model, several challenges
remain. The first set of challenges relates to the beneficiaries. First and foremost, the
project assumes that the beneficiaries come with the qualities and characteristics of a
micro-entrepreneur, especially when it relates to the agriculture sector. This is a strong
assumption. Many of the beneficiary-entrepreneurs may turn out to be deficient in
terms of their abilities, notwithstanding the training and capacity building inputs
provided to them. Behavioral traits, such as, indolence, apathy, negligence and
impatience are hard to change. To get over their deficiencies, several farming tasks are
outsourced and the cost is charged to the beneficiaries according to mudaraba rules.
Further, lack of financial acumen on the part of the beneficiaries is likely to deter a
proper understanding of the mudaraba contract and its implications in terms of rights
and obligations of the parties. The second set of challenges is institutional. Compared to
traditional banking and microfinance products, micro-mudaraba is a new financing
methodology that requires developing much of the procedures and mechanisms de
novo. At the same time, these are likely to be more complex, especially when these
involve multitude partners. The third set of challenges come from a lack of an enabling
environment, such as, weak mudaraba laws. A major challenge may be in the nature of
political interventions that send a wrong signal about the product being noncommercial.
Macroeconomic developments, such as, high inflation rates may also
wreak havoc on financial estimates.
5.4 Wad-Balal livestock development
Livestock production is an important component of the local economy in Sudan,
providing food, employment, foreign exchange earnings, a source of wealth, and supply
of inputs and services, such as draught power, manure and transport. The livestock
subsector however, faces numerous constraints, including a heavy disease burden, low
productivity exacerbated by drought and insecurity, the lack of adequate marketing
infrastructure, and poorly organized and informed livestock owners and traders. The
Wad Balal cattle fattening project of IRADA involving an investment of SDG 9.30
million (about USD 1.68 million) aims to curb poverty by addressing many of the above
problems. The project aims to produce 7,000 cattle annually meeting export standards,
link the poor livestock herders with international markets utilizing contacts of the
Sudanese diaspora and increase incomes of an estimated 250-300 poor families. The
model underlying the project is presented in Figure 3.
The model. The model of intervention involves three parties – IRADA of BoK; the
Wad Balal Company owned by a group of Sudanese diaspora in the GCC; and the Wad
Balal Association with cattle farmers as members. Under the arrangement, IRADA will
have a diminishing musharaka agreement with the Wad Balal Company to invest in the
required physical assets and create a facility for fattening of the calves. The Company
will provide the technical services for the project. The Musharaka will provide the
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facility/assets on ijara or lease to the Association comprising the farmers. IRADA and
the Company will share the lease rentals from the farmers, as received by the
Musharaka. The latter will buy out the share of the former over a period of five years
by using a share of its profits. Further, a pre-agreed share of the profits of the Company
would be used to provide social benefits to the local community. The Association will
sell all the cattle post-fattening to the Company, which will ensure quality standards
and export the same to international markets. At another level, IRADA will provide
murabaha financing for purchase of calves to the Association. Murabaha financing in
bulk reduces the cost of purchasing calves. The project, by facilitating the production
of 7,000 export quality cattle every year and, by linking the farmers to the international
markets, enhances incomes of 250-300 poor families.
Financing method. The musharaka between IRADA and Wad Balal Company
was formed with 95 percent of capital contributed by the former (amounting to SDG
5.04 million) and 5 percent by the latter. The musharaka would make direct
investments in hangers, electric sources, water sources, and fattening supportive
investment that include cooling storage, services facilities, securities facilities, living
allowance of beneficiaries and technical support. The financing tenure is five years.
The lease of the cattle fattening facility to the association would bring in rentals at
18 percent per annum on ijara of assets used for cattle fattening to the association.
The revenues from ijara is shared between Wad Balal Company and BoK as per the
agreed terms of diminishing musharaka. The murabaha financing amounting to SDG
4.26 million will involve murabaha to purchase calves for Wad Balal Association at
IRADA – BoK Wad Balal Company
Fattening
Wad Balal Facility
Association
Farmers
Tech Consultant (WBC)
3
1
2
6
7
4
5
OVERSEAS MARKET
8
Notes: Arrows denote specific activities as follows: (1) diminishing Musharaka
agreement between BoK and Wad Balal Company (WBC) to create fattening
facility; (2) Bok helps farmers form Wad Balal Association (WBA); (3) Murabaha
agreement between BoK and farmers represented by WBA to finance purchase of
calves; (4) Ijara agreement between Musharaka and WBA to use facility in lieu of
payment of rentals; (5) use of fattening facility by farmers to make the calves
grow; (6) technical consultancy and training by WBC; (7) delivery of cattle by
farmers to WBC; and (8) sale of cattle by WBC in overseas markets
Figure 3.
The Wad Balal
Project
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15 percent profit margin. BoK will provide 100 percent financing for calves in the first
two years; which will gradually reduce to 25 percent in the fifth year.
Non-financing services. As before, this initiative also involves a multitude of nonfinancing
intervention/services that include the following: technical support throughout
project lifetime to ensure production quality and cattle vet services, establishing linkage
with Wad Balal Company with access to market in GCC countries, assistance in
managing the project accounts, and formation of Wad Balal Association of farmers.
Risk management. An agri-venture like Wad Balal faces several risk factors,
many of which relate to the marketability of the cattle that are reared by the farmers.
The success of the project hinges on mitigating these risks to acceptable minimum.
Below we list some major risk factors identified by BoK and the various measures
to address them:
• Diseases: the project provides on-site veterinarian services to treat and prevent
cattle diseases.
• Lack of quality and specifications (e.g. health, weight) for export market: on-site
technical services are provided to educate farmers how to raise the quality of
their livestock and meet international standards.
• Unmet basic needs of farmers: families are provided living allowance.
• Inability to market: the Wad Balal Company, which has strong export, links with
the GCC countries have committed to purchase the cattle at a fair price.
• Lack of commitment by farmers: this risk is mitigated considerably by retaining
the right with BoK to remove a shirking beneficiary and replace with another
committed worker. This is backed by stringent performance monitoring. Good
performance is also incentivized with BoK having the right to distribute a larger
proportion of profits based on performance and commitment. Performance of
individual farmers is also monitored at the Association level.
5.5 Building strategic food reserve
Under another program involving multiple partners, IRADA microfinance aims to
purchase goods efficiently from farmers for sale to the Government of Sudan’s strategic
food reserve. This would replace the intermediary and ensure a better price for farmers
for their produce based on official advance purchase rates determined by the Ministry
of Agriculture. This ensures that the farmers’ incomes increase and more farmers are
motivated to produce for livelihood in addition to subsistence. The other partners in
this program are the Ministry of Agriculture and the Ministry of Social Welfare of the
government of Sudan, the Zakah Chamber of Sudan and the World Food Program.
Under this program, IRADA provides salam financing with a tenure of a maximum
of eight months. Its target beneficiaries include 73,000 smallholders under 878 Farmers
Association in seven states (23,677 through direct contract, and 48,396 through
mudaraba with other commercial banks). The program involves multiple parties in a
multitude of roles. IRADA serves as the link between the farmers and other partners
and in grouping the farmers into associations. The Ministry of Agriculture provides
technical assistance for product quality and building the capacity of farmers groups.
The World Food Program provides food for farmers during the planting period.
Finally, IRADA provides for coordination and monitoring of partners activities and
links farmers to local, regional and global markets.
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6. Lessons and way forward
Agricultural growth has a direct impact on poverty by raising farm incomes. It indirectly
impacts poverty through generating employment and reducing food prices. When
centered on smallholder farmers, it requires creative and innovative interventions that
involve provision of a range of financial and non-financial services to them. The latter
include technical skill enhancement of the farmers as well as their empowerment through
producer organizations. This paper undertakes a review of a range of interventions
that have been undertaken in recent years to achieve the same in the Islamic framework.
An alternative approach has been attempted in these experiments. This is based on the
argument that the conventional products and services may not be acceptable to farmer
communities in the Islamic societies, since these violate some fundamental religious
and cultural norms. The key lessons from the case studies included in the paper are
highlighted below.
The conventional lending methodology for the rural poor is rejected in the Islamic
framework on a fundamental ground. Islam prohibits any gain or price for credit.
It does not permit any increase in the quantum of debt due to what we know as the
“compounding of interest.” Thus, while Islamic finance includes products that create
debt, it curbs automatic expansion of credit. Given that the clients come from the
poorest strata of the society, there is merit in a more “humane” form of credit that rules
out penalties for genuine delays in repayment. The paper presents the case of IsMFIs
offering bai muajjal, murabaha, ijara, bai salam where the quantum of debt obligation,
once created and determined, is not permitted to take any other value due to its
restructuring. Nor are penalties a source of income for them.
A review of various Islamic modes that are used for provision of finance to farmers
reveals that there is no one-size-fits-all mode, even though bai salam is widely seen to
be the appropriate mode for agricultural finance. Further, Shariah-compliance of a
mode does not by itself ensure freedom from exploitation. As the examples show,
salam can often involve exploitation when the advance price paid to the poor farmer
is artificially pegged at low levels due to his/her weak bargaining power. Identifying
appropriate organizational structure, e.g. a farmer’s cooperative, may replace the
vendor and thus prevent exploitation of individual farmers by the latter. Similarly,
rates on murabaha and ijara financing can be and often are exploitatively high.
In case of participatory modes e.g. mudaraba, musharaka and muzara’a the sharing
ratio could be unfairly biased against the poor beneficiary because of their low
bargaining power. Prudential regulation of markets is an important pre-condition to
ensure healthy and adequate competition among the players and thereby, remove
abnormal and/or illegal profits through mispricing. Of course, these “exploitation”
concerns apply to for-profit modes only and call for a greater reliance on not-for-profit
modes of microfinance.
Islamic finance discourages debt based products and encourages equity and
partnership based products in general. Given that conventional MFIs derive their
income from interest, they seem to be inclined to push their clients into larger and
larger amounts of debt. In the Islamic approach, debt is not just discouraged; there are
built-in mechanisms, such as zakat to address over-indebtedness of an individual.
The paper documents the cases in Sudan where an institutional mechanism exists for
use of zakat for curbing indebtedness.
Islamic finance requires “simplicity” in contracts where the rights and obligations
of the parties are well understood by them. Even where an Islamic finance model
includes future obligations, or composite structures, the uncertainty and ambiguity
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factor is kept to the minimum. The diminishing musharaka based models used in
Sudan are apparently complex but quite “definitive” in terms of transfer of ownership
of the key assets into the hands of farmers over a finite period.
While credit and finance are key inputs for transforming the lives of the farmers,
they often require a wide range of non-financial services. Identifying these nonfinancial
needs and finding creative and innovative solutions thereto is critical for
success of any intervention. The paper documents a range of such services provided in
Indonesia, Guinea and Sudan in particular including: technical assistance, skill
enhancement, procurement, production, warehousing, processing, packaging and
marketing support that underlies the success of these interventions.
A related question is how these non-financial services are to be funded. Should they
be priced? Should the farmers pay for these services? The cases documented in this
paper highlight both commercial and philanthropic approaches to the issue. While in
the Sudanese examples, the costs are duly accounted for in the determination of profitshare
for the farmers, the Indonesian experiment provides a zakat-funded approch.
Indeed the inter-mix of philanthropy with a commercial approach is a key feature of the
case studies discussed in this paper.
MFIs that focus on financing the need for physical assets by farmers through
conventional or Islamic credit, or through leasing often ignore the importance of
providing for basic consumption needs. It should not come as a surprise if farmers
resort to diversion of funds from the so-called income-generating project or even
distress sale of the assets (funded by MFIs) if the basic consumption needs remain
unfulfilled. Indeed, in case of the Sudanese projects the provision of safety net by
IRADA is perhaps a significant contributor to the success of the projects.
Community-driven development (CDD) is a recent experiment in poverty alleviation.
Despite the success of this approach, a major constraint with conventional CDD is the
recurring nature of funding requirement while recurring grants may not be
forthcoming. This paper documents a case in Indonesia where zakat is used to fund
subsequent phases of CDD. The Islamic CDD is free from the constraints facing its
conventional counterparts, given that zakat is an annual recurring flow unlike the
conventional grants that may be one-time or erratic at best.
The projects discussed in this paper not only seek to leverage existing skills,
but also develop new skills. Specifically, the Indonesian and Sudanese
interventions seek to take the technical skills of farmers to a completely new level,
which should enable them to create wealth by applying better farming technology on
a sustained basis. The Sudanese projects in particular use an approach similar to
conventional venture capital funding (with some differences, of course) and focus
on the economic viability of project. They carefully seek to identify risks and
mitigate them. They also provide a unique example of combining benevolence with
commercial viability.
To summarize, the case studies presented in this paper provide insights into the
alternative modes and models of Islamic microfinance that are in use to provide
livelihoods, socially and economically empower the farming communities, enhance
food security and alleviate poverty. The need for these solutions arises due to possible
self-exclusion of farmers from conventional microfinance on the ground of their
incompatibility with religious beliefs. The models and tools of Islamic microfinance
display major variations as they seek to provide financial and non-financial support to
the farming communities. While some IsMFIs focus on the provision of micro-credit
to farmers, following an approach similar to that of conventional agri-finance
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and microfinance institutions while ensuring Shariah-compliance of their credit
product(s), a few others prefer a more comprehensive and challenging approach.
The latter group of IsMFIs assume that an MFI must play the role of a pivot in
a process of transformation, and in the economic and social empowerment of the
farming communities. These IsMFIs adopt a “project” approach and provide support in
a multitude of areas other than finance, such as, technology, procurement, production,
marketing, business development, capacity building, and thus, ultimately steering
the project to success.
However, in confronting the multitude of challenges facing the farming
communities, the MFIs may have to limit their outreach significantly. While in case
of credit-based finance, the size of financing per beneficiary is very small, perhaps in
the range of USD 100, the same is very high in case of project-based approaches that
seek to finance the entire value chain. Such partnership-based agri-finance may require
large upstream investments; perhaps placing them in a distinct category of social
impact investment and not in that of microfinance. For instance, the size of financing
per beneficiary is capped at USD 32,000 in case of Abu Halima Green Houses project.
No wonder, while salam-based microfinance by IRADA directly targets over 23,000
farmers, Abu Halima targets a meager 125 agriculture graduates. This naturally raises
the question: Is salam financing the best that Islamic finance can offer in the field of
agriculture? At the same time, it is important to note that projects like Abu Halima
and Wad Balal may have a far more significant long-term impact in terms of
building capacities of farmers as also in enhancing food security. Such projects
help create a new generation of technically superior and highly skilled farmers
increasing the supply of and stabilizing prices of high-value foods. Further replications
of such projects would also bring down the marginal costs. Another unexplored
possibility in Islamic finance is the establishment of awqaf or endowments to take
care of the upstream investments that create permanent or long-lasting facilities for use
of farmers. Such investments need not be funded with bank finance. If so, the quantum
of financing per beneficiary will significantly go down and the outreach of IsMFI may
be significantly increased.
Another interesting dimension of the Abu Halima and Wad Balal projects is the
contribution of grant money by the Ministry of Finance to the Mudaraba, which makes
it possible to offer murabaha financing at a modest rate of fifteen percent. Given the
widely expressed concern about affordability of high-cost microfinance, such a
possibility offers great promise. In a modified model, the Ministry may easily be
replaced with a dedicated waqf, which can pave the way for affordable microfinance for
the poor.
A unique dimension of the Wad Balal project is the fact that a pre-agreed share of
the profits of the Wad Balal company (that serves as the pivot in the structure and
would be eventually owned entirely by the Sudanese diaspora) would be used to
provide social benefits. One may draw a line of comparison between such a corporate
entity and a waqf, which dedicates a certain percentage of its profits for provision of
specific social benefits. Indeed, with minor variations, the two project structures could
easily fit in new situations and find acceptance in a variety of countries and regions. In
the Sudanese scenario, several ministries of the government contribute significantly to
the success of the projects. The active involvement of the ministries of the government
in other countries may give rise to apprehensions and concerns about coordination and
efficiency. As an alternative, the substitution of the institution of waqf for government
may be explored.
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Notes
1. Together, these three countries account for over 440 million of the world Muslim population
(see Central Intelligence Agency, 2014).
2. Food and Agriculture Organization (2013).
3. Pakistan Economic Survey (2014).
4. World Bank (2003) defines smallholders as those with a low asset base, operating less than
two hectares of cropland.
5. The 1970 Unregistered Land Act ensured that any land, occupied or unoccupied, which had not
been registered before the commencement of the Act would be the property of the government.
6. US Country Studies, Library of Congress (1991); also Zaroug (2000).
7. Busschaert (2014) discusses the concept of microfinance for agriculture investment in small farms
(MF4SHF) and presents the mechanism to create high and long-term impact in small farms.
8. For a comprehensive discussion on the Shariah-compliant modes of microfinance, see
Obaidullah (2008a, pp. 55-64).
9. Riba and Gharar being Arabic terms can only be loosely translated. Riba is translated as “excess”
or “growth” and generally implies usury. Gharar is translated variously as “uncertainty”, “risk” and
“ambiguity”. For a comprehensive definition of riba and gharar, see Obaidullah (2005, pp. 21-35).
10. For a comprehensive analysis of istijrar and its possible applications, see Obaidullah (2005,
pp. 190-192).
11. The Grameen model is the text-book model of conventional microfinance that uses jointliability
and group financing as a substitute of collateral in mitigating high credit risk with
the rural poor.
12. For example, neither the price of a cow and a goat are same, nor can one buy, say, one and
half goats for a pre-determined amount of funding. For a case study of RDS, see Obaidullah
(2008b, pp. 14-43) and for a more recent version, Obaidullah and Shirazi (2014, pp. 88-94).
13. See Obaidullah (2014).
14. See Obaidullah and Saleem (2011, pp. 206-216).
15. For a discussion of the Iranian Qard al-Hasan Funds, see Obaidullah (2008a, pp. 37-38).
16. For a case study of Akhuwat see Obaidullah and Shirazi (2014, pp. 81-88).
17. For a comprehensive report on the programs of DDR, see Obaidullah et al. (2014, pp. 66-69)
and Alim (2014).
18. For further details on this program, see Mintarti (2013) and Alim (2014).
19. Gapoktan is a term in Bahasa Indonesian language that refers to small groups.
20. The Arabic term “tamleek” translates into “imparting ownership”, which is an essential
condition for zakat distribution to any beneficiary. For more on this issue, see Obaidullah
(2013, pp. 60-61).
21. See Kaleem and Abdulwajid (2009, pp. 275-292). The estimated percentage of small farms is
larger as compared to the IFPRI (2005) estimate cited earlier.
22. Not surprisingly therefore, it was adjudged to be among the top three participants (Wasil
receiving the top award) at the Global Islamic Microfinance Challenge 2014 organized by the
CGAP (Consultative Group to Assist the Poor), the Islamic Development Bank, Al Baraka
Banking Group and Triple Jump, which evaluated innovative Islamic microfinance
experiments with a focus on product development.
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(accessed October 20, 2014).
Corresponding author
Dr Mohammed Obaidullah can be contacted at: [email protected]
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www.emeraldgrouppublishing.com/licensing/reprints.htm
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Enhancing food security with Islamic microfinance: insights from some recent
experiments
Mohammed Obaidullah,
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Mohammed Obaidullah, (2015) “Enhancing food security with Islamic microfinance: insights from
some recent experiments”, Agricultural Finance Review, Vol. 75 Issue: 2, pp.142-168, https://
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Enhancing food security with
Islamic microfinance: insights
from some recent experiments
Mohammed Obaidullah
Islamic Development Bank, Islamic Research and Training Institute,
Jeddah, Saudi Arabia and
Faculty of Muamalat and Administration,
Islamic Sciences University Malaysia, Kuala Lumpur, Malaysia
Abstract
Purpose – Islamic microfinance institutions (IsMFIs) have used diverse models and tools, as they seek
to provide financial and non-financial support to the farming communities. A majortity of IsMFIs
focus on provision of micro-credit to farmers alone as a means to enhance food security, following
an approach similar to that of the conventional microfinance institutions. Others adopt a “finance-plus”
approach and provide support in a multitude of areas other than finance, such as, technology, production,
marketing, business development, capacity building, and thus, ultimately steering the project to success.
The purpose of this paper is to examine the models and tools of Islamic agricultural finance for the rural
poor that display major variations and draw lessons from a policy perspective.
Design/methodology/approach – The study undertakes a comprehensive review of the principles,
modes and models of Islamic agricultural finance targeted at small-holder farmers. It uses a case study
method to review several winning initiatives by IsMFIs across the globe. It highlights the various risks
and challenges confronting the projects and how the same are sought to be mitigated.
Findings – Islamic agricultural finance for the rural poor involves a range of modes, mechanisms
and institutional structures. Credit-based and sharing-based modes work well under specific conditions
and there is no one-size-fits-all solution for financing the rural poor. Case studies of successful
initiatives reveal that composite models involving the integration of philanthropy-based, not-for-profit
as well as for-profit components may provide ideal solutions. Additional factors critical for success
include provision of safety nets, involvement of community, non-financial support in a multitude
of areas other than finance, such as, technology, procurement, production, marketing, business
development and institutional capacity building.
Originality/value – The paper addresses a fundamental issue in financing the poor farmers
in Muslim societies – whether to opt for a credit-based approach that would ensure greater outreach
or to go for a holistic intervention involving financing of the entire value chain. The findings are based
on personal interaction of the author with professionals directly involved in the projects.
Keywords Food security, Agriculture finance, Islamic microfinance, Livestock finance
Paper type Case study
1. Introduction
Agriculture plays a major role in enhancing food security and employment
opportunities in several countries with large Muslim population, such as, Indonesia,
Pakistan and Sudan[1]. It is a significant contributor to the gross domestic products
(GDPs) in these countries. In Indonesia, it accounts for over 15 percent of GDP with
around 40 percent of the working population employed in this sector[2]. In Pakistan, the
corresponding figures are 21 and 45 percent, respectively[3]. In Sudan as well, it is
estimated that the sector contributes 35-40 percent of the GDP. Yet, there has been a
growing incidence of the farming community in these and other countries seeking
alternative sources of livelihood triggering concerns about food security. Key factors
Agricultural Finance Review
Vol. 75 No. 2, 2015
pp. 142-168
©Emerald Group Publishing Limited
0002-1466
DOI 10.1108/AFR-11-2014-0033
Received 5 November 2014
Revised 28 December 2014
26 February 2015
Accepted 19 March 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/0002-1466.htm
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contributing to this in Indonesia include, among others, declining soil fertility, high
input prices, limited capital, human resources with low and limited skills, fluctuating
crop prices and above all, continuously declining terms of trade (Mintarti, 2013). In
Sudan, the problems are further accentuated due to natural calamities in the form of
droughts and civil strife. In Pakistan too, the story is similar. Land access is increasingly
becoming a key constraint for many farmers forcing them to seek migration to urban
areas in search of alternative sources of livelihood. Studies also show that these
countries are characterized by large and increasing number of small farm holdings[4].
An IFPRI (2005) study estimates that Indonesia has about 17.2 million small farms
accounting for 88 percent of all farms, while Pakistan has about 3.8 million small farms
that constitute 58 percent of all farms. The numbers are also steadily increasing along with
a decline in average size of holdings. For example, the average size of holding in Indonesia
declined from 1.1 hectare to 0.9 hectare over 1973-1993, the same for Pakistan declined
from 5.3 hectares in 1971-1973 to 3.1 hectares in 2000, during which time the number of
small farms more than tripled. Sudan presents an interesting contrast with the
government owning large tracts of agricultural land[5]. Agricultural holding size varies
according to the region and system of production. For example, in central Sudan the
government has proactively encouraged mechanized and large-scale farming. The rest of
the country has private small-scale farming where the size of holding has continuously
declined due to fragmentation because of the operation of the Islamic law of inheritance[6].
Small-scale farmers are the “economically active” poor who witness grave food
insecurity and abject poverty. Agriculture is highly dependent on the local conditions:
availability of and access to good land, soil, water, climate and market. Further, crops
vary widely in terms of duration, perishability, and seasonality. Therefore, provision of
microfinance requires different products, diverse and tailor-made approaches. Recent
best practices in conventional microfinance advocate “local” interventions based on a
value chain approach[7].
A major challenge confronting such microfinance is related to the belief systems of
the farmers. Conventional microfinance involves interest-based savings and loans to
farmers, which is against the tenets of Islam, the predominant religion in the countries
under focus. A study by Karim et al. (2008) undertaken for CGAP based on a survey of
the poor in Muslim societies concludes that Islamic microfinance, that is in compliance
with the religious tenets “has the potential to combine the Islamic social principle of
caring for the less fortunate with microfinance’s power to provide financial access to
the poor. Unlocking this potential could be the key to providing financial access to
millions of Muslim poor who currently reject microfinance products that do not comply
with Islamic law.” Islamic microfinance, therefore, is seen as a solution to the challenge
of self-exclusion.
Several Islamic microfinance experiments have been undertaken in recent times in
predominantly Muslim countries. These poverty alleviation initiatives by the Islamic
microfinance institutions (IsMFIs) in the rural areas have sought to counter food
insecurity and generate livelihoods by focussing on the agricultural and livestock
sectors. IsMFIs have used diverse models and tools of Islamic microfinance, as they
seek to provide financial and non-financial support to the farming communities.
A majority of IsMFIs focus on provision of micro-credit alone to the farmers, following
an approach similar to that of the conventional microfinance institutions. Wadud (2013)
for example, argues that policies, which extend microcredit and ensure fair, timely and
low-cost delivery of microcredit to marginal and small farmers, could lead to reduction
of agricultural farm inefficiency and hence, lead to improvement of performance of
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farms. This could enhance farm output and welfare, help reduce poverty and improve
food security. Of course, the IsMFIs that offer microcredit must additionally ensure that
the credit product(s) offered by them are based on Shariah-compliant modes, such
as, murabaha, bai muajjal and bai salam[8]. Other IsMFIs prefer a more comprehensive
and challenging approach. These IsMFIs believe that they must play the role of an
anchor and a facilitator in a process of transformation, and in the economic and social
empowerment of the farming communities. They prefer to adopt a “project” approach
and provide support in a multitude of areas other than finance, such as, technology,
production, marketing, business development, capacity building, and thus, ultimately
steering the project to success.
The aim of this paper is to introduce the reader to the basic principles of Islamic
microfinance as applied to the agricultural and rural sector. It seeks to highlight the
diversity in Islamic agricultural and rural financing modes and models and to underline
their potential reach and richness. The objectives include, among others, a comprehensive
micro-level analysis of selected experiments in agricultural microfinance in diverse
scenarios. The study uses a case analysis method to present the alternative approaches
and composite models and seeks to draw lessons therefrom so that the good practices may
be replicated elsewhere and bad practices, if any, may be avoided.
In the following section, we undertake a general discussion of the principles
and modes of Islamic agricultural finance as undertaken in a majority of case studies.
The following three sections present a few successful composite models of intervention.
Section 3 presents a case study of economic and social empowerment of farmers by
Dompet Dhuafa Republika (DDR), a leading non-government organization in Indonesia.
Section 4 presents a case study on an award-winning agri-finance product portfolio
by Wasil, a pioneering non-government organization in Pakistan. Section 5 presents
case studies of three unique projects of the microfinance unit (IRADA) of the Bank of
Khartoum (BoK) in Sudan. Section 6 summarizes the key lessons and concludes.
2. Islamic framework for agricultural finance
The Islamic framework for agricultural finance seeks compliance with several
fundamental Shariah norms. The two most important and relevant norms are:
prohibition of riba and prohibition of excessive gharar[9]. The first essentially rules out
any financial or non-financial gains for the lender offering credit-based products. The
second rules out excessive risk, uncertainty, undue complexity and conditionality in the
financial products. Islamic finance literature identifies several modes for provision of
agricultural finance that conform to the above. While some of these modes are sale or
lease-based and create debt obligations on the part of the farmer, others are sharingbased
and create partnerships between the farmer and the financial institution.
2.1 Bai muajjal-murabaha (credit-cost plus sale)
Bai muajjal is a sale where payment of price is deferred to a future date. Often it
includes features of a murabaha, which implies a sale on a cost-plus basis. As a microcredit
product, bai muajjal-murabaha is the most popular product among IsMFI
accounting for over two-third of the total Islamic microfinance portfolio (El-Zoghbi and
Tarazi, 2013). The mechanism may be described as follows. Farmer A needs to
purchase farm equipment or livestock X. He approaches the IsMFI. Now, the IsMFI
buys X from the vendor/supplier at price P. Next, IsMFI sells X to A at a marked-up
price, say P+M, where Mis the agreed profit or mark-up taken by IsMFI. The payment
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of price P+M is deferred to a future date and is made in full or in parts. This Islamic
credit product comes very close to the conventional interest-based credit, which
perhaps explains its popularity with the IsMFIs. Yet, there is a clear line of distinction
between the two. The quantum of debt created under the former is the price of the
underlying commodity that is fixed at the time of contracting and that remains at this
level even if the maturity of the product is extended subsequently. In conventional
credit products, however, the quantum of debt increases, compounded at the interest
rate as maturity increases (as in case of loan restructuring).
Bai-Istijrar is a variant of the bai-murabaha and takes place when the buyer
purchases different quantities of a given commodity from a single seller over a period
of time. Istijrar permits greater flexibility in the matter of fixation of price, which may
now be deferred to a future date (and not at the time of contracting as in bai-murabaha)
and may indeed be based on a normal price or average price in a volatile market.
This mode, thus, offers a natural way to reduce price risk. Though ideal for rural finance
where farmers often buy their raw materials and inputs in small quantities from the same
IsMFI over extended periods, istijrar has not been used extensively to date[10].
Several studies (Obaidullah, 2008b) and (Obaidullah and Shirazi, 2014) have
documented the case of the Rural Development Scheme (RDS) of the Islami Bank
Bangladesh that replicates the Grameen model[11] but uses bai muajjal (replacing
Grameen interest-bearing loan) as its primary mode of meeting the financing needs
of the farmers and the rural poor. The case studies highlight some possible issues of
Shariah non-compliance. For instance, in bai muajjal finance, one would expect the
amount of financing to vary, given that the wide range of commodities being financed,
have different prices. RDS on the contrary, provides a uniform financing amount,
similar to the basic loan of Grameen. This involves practical impossibilities, since
many commodities are not perfectly divisible and be the subject of exchange in
fractional units[12]. Further, bai muajjal may not be suitable for financing all kinds of
income-generating farming activities, such as, growing vegetables, fishing and other
agri-based activities. While bai muajjal can be used to finance the purchase of saplings,
fertilizer, fishing nets and so on, in practice, the farmers would need funding not just
for the physical asset(s) involved, but also to finance the working capital requirement.
Bai muajjal, thus, provides a partial solution only.
Another issue with RDS use of bai muajjal arises out of the Shariah requirement of
settlement of each of the two sale transactions sequentially in a single bai muajjal.
In a scenario where farmers need to buy their raw materials and inputs in small
quantities repeatedly, meeting the above Shariah requirement in bai muajjal may
involve substantial non-financial costs. As mentioned above, the use of bai istijrar in
such cases is possible and desirable too, as it can reduce such transaction costs.
However, its potential remains largely untapped.
2.2 Ijara (leasing)
Ijara in simple terms implies leasing or hiring of a physical asset. It is also a popular
and flexible product in which the IsMFI owns a physical asset (e.g. land, farm
equipment) and leases the same to the farmer. The farmer in need of the asset receives
the benefits associated with its ownership against payment of predetermined rentals.
In ijara, the risks associated with ownership of the asset remain with the IsMFI and the
asset reverts to the IsMFI at the end of the ijara period. Ijara is, therefore, similar to
conventional operational lease (though there are finer points of distinction including
use of penalties and interest in some scenarios). Ijara works well in a scenario where the
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IsMFI is organized as a farmers’ cooperative or an organization that primarily serves
the farmers. Pure financial intermediaries prefer a lease ending with ownership of the
asset by the lessee-farmer. In such an arrangement, the cash flows are structured in
a way that cover the cost of the asset and provide for a fair return on the same to the
IsMFI. The IsMFI after recovering its cost and fair return may simply donate the asset
or sell the asset at a nominal price to the farmer.
2.3 Bai-salam (deferred delivery)
Bai-salam is essentially a forward agreement where delivery occurs at a future date in
exchange for spot payment of price. Unlike earlier mechanisms of bai muajjal and ijara,
salam or salaf was originally designed as a pre-cultivation financing mechanismfor small
farmers. Under a salam agreement, a farmer in need of short-term funds sells its output in
advance to the IsMFI on a deferred delivery basis. It receives full price of the farm output
on the spot that serves its pre-cultivation financing needs. At a pre-agreed future date, it
delivers the output to the IsMFI. The IsMFI then sells the output in the market at the
prevailing price. Since the spot price that the IsMFI pays is pegged lower than the
expected future price, the transaction should result in a profit for the IsMFI.
Thus, under salam the farmers would receive the price of their produce in advance at
the beginning of agricultural season against an obligation to deliver a defined quantity
of the produce to the buyer after a definite time period in future (after harvest). The sale
price received in advance is available to the farmer as a means of financing all farming
related needs. Another advantage is that the farmers do not have to sell their produce
at a time when the market has an oversupply due to harvest, thus depressing the prices
and bringing down the realized income of farmers. While the mechanism provides for
much needed financing, it is subject to abuse by unscrupulous intermediaries and traders
who seek to take advantage of low bargaining power of the poverty-ridden farmers and
execute salam at unrealistically low prices. To counter this, mutuality-based models of
microfinance have been suggested. Farmers’ cooperative organizations can dramatically
enhance the bargaining power of farmers and replace intermediaries. In a salam-based
framework, these cooperatives would provide funds in the form of advance price and
would take delivery of the produce after harvest as above. The cooperative would also
create appropriate warehousing facilities for storage of the produce and market the same
in a manner that avoids depressed prices resulting in increased income for the members.
The Jeddah-based Islamic Development Bankmay be credited with pioneering this model
successfully. The model involves creating cooperatives (mudarabas) of farmers, and
placing funds with them for salam financing to member farmers as well as providing
other non-financial services relating to warehousing, processing, packaging and
marketing services in a few of its member countries, such as, Guinea and Palestine[13].
Another problem with classical salam for the financier arises out of its exposure to
price risk or market risk. A financier who is not an astute player in the market for the
concerned commodity and does not fully understand the economics of pricing in this
market may be confronted with adverse prices and consequent losses when it seeks to
sell the produce upon delivery by the farmer(s). This problem may be taken care of in
several ways. First, a back-to-back salam under which the IsMFI enters into a parallel
salam with a market vendor (say, a miller) and locks a forward price mitigates their price
risk. Once the farmer delivers the output to the IsMFI, the same in turn is delivered to
the vendor. The difference between the two advance prices is pre-determined profit for
the IsMFI. Second, a variant of bai salamcalled value-based salamis specifically designed
to mitigate price risk. This may be explained with the following example.
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In a classical salam, the quantity of object of sale (agricultural produce) and the price
per unit of the object of sale are pre-determined at the time of contracting. If Q amount
of paddy is sold on forward basis at price P on salam basis, then the financier (buyer)
would pay the value of transaction PQ to the farmer (seller) at the time of contracting
(before commencement of farming). After a defined and known time period (harvest
time), the farmer would deliver Q amount of paddy to the financier. The financier in
turn, would find a way to dispose of Q amount of paddy in the market at the prevailing
market price P*. If market price increases during the financing period, P* would be
higher than P. In other words, P*Q would be higher than PQ and the financier would
have positive profits (P*Q−PQ). If however (and this is quite likely given the abundant
supply of produce during harvesting season) the prevailing market price is depressed
and P* is lower than P, the financier would end up with losses. The value of P*Q−PQ
would be negative. This market risk or price risk is mitigated in case of a value-based
salam. In the latter type of salam, the MFI would pay an amount (say V) to the farmers’
cooperative at the time of the contract against an obligation of the farmer to repay in
physical quantities of its produce whose value at the time of delivery at a future
date (after harvest) is pre-determined (say V*). In other words, the farmer would deliver
V*/P1 quantity of paddy to the MFI if the future price at the time of delivery is P1 and
V*/P2 quantity of paddy if the future price is P2 and V*/P* quantity of paddy if the
future price is P*. This settlement value (V*) may indeed be pegged higher than the
original value (V) received in advance by the farmer resulting in a known profit (V*−V)
to the financier. While this form of contracting is not well known, Obaidullah and
Saleem (2011) presents a case study involving its application in Sri Lanka. The case
study documents the case of Muslim Aid (MA) Sri Lanka seeking to take care of the
safety needs of the poor farmers, to build a sustainable source of funds for them as
a cooperative organization and to free them from exploitation by trader-middlemen by
intervention through the market mechanism. MA also sought to create a win-win
situation for the trader-middlemen by forming a partnership with them.
MA used a multi-stage model for provision of finance and other inputs to the
farmers. The first stage involves a creative variant of the classical bai-salam or
“deferred delivery” transaction. Under this mechanism, a farmer was provided funds
in advance against a forward sale of his produce at the time of harvest. The funds were
used by the farmer to finance purchase of the necessary inputs to start paddy
cultivation. Unlike bank financings, no collateral was required from the farmer. Instead,
a farmer needed to obtain a set of recommendations from the local mosque and
community leaders who acted as guarantors. The second stage began at harvest time
once the agricultural produce was delivered to MA. It involved a partnership between
MA and local miller(s) to take possession of the harvested paddy from the farmers,
process it and sell the final product at the market with the profit being shared between
MA and the miller(s) on the basis of a mudharabah partnership. It was expected
that the profit share of MA would cover the administration cost of the financing.
In order to ensure that the over-all model was a not-for-profit one and that it was also
sustainable one, any surplus of profit share over administrative cost was to be used to
create a Revolving Fund for the farmers (see Figure 1). Farmers enjoying incremental
income were also expected to make zakah contributions to this Fund and therefore,
adding to its size and ability to provide financing to greater numbers. This was the
third stage of the model[14].
The modes discussed above, involve credit and may be used by an IsMFI as
Shariah-compliant modes of extending micro-credit to farmers. A major problem
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associated with such modes relates to the possibility of willful default by clients. Unlike
conventional microfinance where defaults may result in additional interest payments
and/or rescheduling of loan, and where prepayment may result in rebates, Islamic
modes do not admit the possibility of any payment in excess of the original amount of
debt. Islamic scholars generally permit the IsMFI to impose a penalty on the defaulting
client to act as a deterrent against willful default, but such penalty must be donated to
a charity. It cannot be treated as an earned income for the IsMFI as this would
tantamount to riba. Such income is indeed reported in the financial statement of IsMFIs
as “non-halal” or impermissible income that must be donated.
2.4 Mudaraba-musharaka (trustee partnership-joint venture)
IsMFI may also consider various partnership based modes or equity-based modes for
financing poor farmers. Two classical modes commonly discussed in this context are
mudaraba and musharaka. We also discuss a novel concept of declining musharaka
leading to complete ownership of asset or project by the farmer. These equity-based
products are unique to Islamic rural finance and in some sense, account for its superiority
over its conventional counterpart on grounds of ethics and efficiency. Arguably, because
of their uniqueness, they are also less commonplace.
A mudaraba also known as trustee-partnership is a mode of finance through which
the IsMFI provides capital finance for a specific agri-venture initiated by the farmer.
The IsMFI, called rabb-al-mal is the owner of the capital and the farmer, called mudarib,
is responsible for the management of the agri-venture. Profit is shared according to
a pre-agreed ratio. Losses if any are entirely absorbed by the capital provider – the
IsMFI. Mudaraba may be of two types – restricted or unrestricted. In a restricted
mudaraba (mudaraba al-muqayyada), the IsMFI may specify a particular business
in which investments may be undertaken. Mudaraba may also be an unrestricted one
(mudaraba al-mutlaqa); in which case the mudarib may invest the capital provided in
any venture (s)he deems fit.
A musharaka or a joint venture involves a partnership in which both the IsMFI and
the farmer contribute to entrepreneurship and capital. It is an agreement whereby the
farmer and the IsMFI agree to combine financial resources to undertake a venture, and
agree to manage the venture according to the terms of the agreement. Profits are shared
between the IsMFI and the farmer in the pre-agreed ratio. Losses are shared strictly in
proportion to their respective capital contributions.
A variant of musharaka that has traditionally been used in Muslim societies for
agriculture is muzara’a or output sharing. This mode allows the owners of inputs for
Salam (Value-Based) Mudaraba
Money to
farmers as
price in
advance
Repayment in
paddy plus
zakah
Process
paddy and sell
in market at
profit
Recover
admin cost +
profit +
capital
5 Months 5 Months
Profit Figure 1.
Overview of
MA model
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agriculture, e.g. land and labor to come together and undertake cultivation. The
output post-harvest is shared between the land owner and the laborer (landless farmer)
as per a pre-agreed ratio. Another variant known as musaqa is a contract between the
owner of an orchard (of fruits or vegetables) and a farmer who can irrigate and look
after the orchard. The output of the orchard is shared between the parties as per a
pre-agreed ratio.
An interesting project (supported by the Islamic Development Bank) to help poor
olive farmers in Palestine involves use of a composite model. The IsMFI is involved in
each step of the olive value chain. First, it facilitates a muzara’a agreement between
the landowners and the poor farmers. It provides salam financing for olive seeds
and fertilizers. The olive harvest collected by IsMFI is sold to olive oil mills for a profit.
The uniqueness of this model as compared to conventional model is as follows. In the
event of loss due to crop failure: the landowners would lose potential income under
profit-sharing; the farmers would have to pay back (cash or in kind) to the IsMFI
no more than the advance payment and the IsMFI would lose potential profit from sale
of olives to oil mills. Under the conventional model, however, a different set of outcomes
would be in place in case of crop failure. The farmers would have to pay rentals due
to landowners; principal loan due to MFI; and interest due to MFI. In short the poor
farmers would have to bear the entire downside risk with agriculture.
Another variant of musharaka called diminishing musharaka has great potential
for the IsMFI as a financing product. While a classical musharaka aims to involve
the IsMFI as a permanent partner in the venture, in a declining musharaka, the IsMFI’s
share in the equity is diminished each year through partial return of capital. The IsMFI
receives periodic profits based on its reduced equity share that remains invested during
the period. The share of the farmer in the capital steadily increases over time, ultimately
resulting in complete ownership of the venture.
Agency problems with partnership-based modes in Islamic finance are cited as the
key reason behind preference of mainstream Islamic financial institutions (IsFIs) for
debt-based products. The problems – for example, when the mudarib or the trusteemanager
may act in a manner that is not in the best interests of the capital-providers –
become particularly acute in informal and rural settings. A few other problems that are
usually cited with partnership-based modes as compared to sale and lease based modes
are as follows: One, partnership-based mechanisms require long-term involvement by
the microfinance institutions in the form of technical/ business assistance, which raises
the cost of implementation. Two, the uncertainty about profits is a major drawback of
such modes. Although microfinance programs have information on local market
behavior, weekly profits fluctuate. Fluctuating profits make it extremely difficult for
institutions to predict their cash flows. Farmers can make the job doubly difficult by
not keeping accurate accounts. Three, the partnership-based modes are difficult to
understand for IsMFI officers and borrowers alike. Even in the hypothetical situation
that profits were known, the borrower has to repay a different amount each period (and
the officer has to collect a different amount each period). This lack of simplicity relative
to equal repayment installments is a source of confusion for borrower-farmers and
IsMFI officials. Unlike profit-sharing mechanisms, bai muajjal does not require the
farmer to maintain written records that are often unavailable at the rural enterprise
level or if available, the farmer may be unwilling to share them.
While IsMFIs may use some or all of the above for-profit modes in the interest of
sustainability, their mission driven approach of helping the rural poor requires
provision of a mix of financial and non-financial services that include handholding and
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other forms of support to farmers. The overall objective is benevolence-driven and
often strictly not-for-profit. Indeed, Islamic economics and finance provide a range of
benevolence-driven, philanthropy-based and not-for-profit mechanisms as well, whose
importance can be hardly overemphasized, especially when seeking to address the
financing needs of the poor farmers.
2.5 Qard al-hasan (interest-free loan)
Qard hasan literally means a beautiful loan. It is a loan granted by the lender without
expectation of any return on the principal. Islam provides very strong incentives for
lenders to meet the financial requirements of the needy by providing loans without
expecting any gain in return from them. Any such return expected or demanded by the
lender is forbidden riba. It is pertinent to note several things here. First, the lender is
permitted to recover the actual cost it incurs in the process from the beneficiary or the
borrower. However, the amount charged to borrower must not be more than the actual
cost of operation. Thus charging the borrower based on notional or estimated cost of
operation is ruled out. Two, Islam exhorts a borrower to be generous when (s)he repays.
(S)he is allowed and indeed, encouraged to return more than (s)he originally borrowed
from the lender. The excess is viewed as a gift (heba) from the borrower and is
permissible as long as it is not demanded (stipulated in the contract) by the lender.
A Muslim is also encouraged to avoid debt. (S)he should strive to get out of debt if (s)he
is already trapped in it. (S)he must make all efforts to repay the loan as early as
possible. At the same time, Islam encourages a lender to give extension in time or waive
part of the loan, should the borrower be forced to default. It completely rules out any
penalty for default that is unintentional. However, in case of willful default or
delinquencies, a penalty may be imposed as a deterrent. Such penalty, once collected,
must be donated to charity and cannot form part of the income of the lender. At an
institutional level, one finds that this mode forms the basis of over 6,000 Qard al-Hasan
Funds (QHFs) dotted across Iran, which provide microfinance primarily to the rural
poor[15]. The QHFs raise funds using the qard al-hasan mode from their depositors;
and lend onwards also using the same mode. Another interesting application of this
mode on the lending side only (funds are raised through charity) is the Akhuwat model
in Pakistan[16].
2.6 Sadaqa, zakat and waqf (charities and endowments)
The broad term for charity and philanthropy in Islam is sadaqa. Sadaqa is in the nature
of free donation without any strings attached. When compulsorily mandated on an
eligible Muslim, sadaqa is called zakat. When sadaqa results in flow of benefits that are
expected to be stable and permanent (such as, through endowment of a physical
property), it is called sadaqa jariya or waqf.
Zakat is an institution of philanthropy mandated by faith. It may also be seen as a
compulsory levy on every believing and practicing high-net-worth Muslim. From
a macroeconomic perspective, zakat is a source of recurring annual flow of funds. Since
Islamic law restricts the allocation of zakat funds to eligible beneciaries alone, that
primarily include the poor and the needy, zakat is potentially a major tool of poverty
alleviation. It is more in the nature of a safety net to take care of the basic necessities
of life of poor farmers who cannot afford them. Additionally, zakat funds can be used
in a variety of ways for the farmers; for skill enhancement, provision of start-up capital,
or pay off the debt of the over-indebted farmers as long as the beneficiaries suffer from
abject poverty.
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Waqf, which essentially implies the irreversible endowment of an asset of value
(e.g. real estate, cash) by a donor with a stipulation that the returns generated through
investment of the asset or the benefits flowing out of the asset are used for specified
purposes. Thus waqf, by definition, provides for a sustainable source of funds/ benefits
that may be targeted at the poor farmers.
To sum up, Islamic finance provides a fairly broad range of modes and mechanisms
that may be used for provision of financial and non-financial services and support to
the poor farmers. Often some or all of these charity-based, not-for-profit and for-profit
mechanisms are combined in models to provide holistic solutions to the problems of the
poor farmers, alleviate their poverty and help them enhance food security. In the next
three sections, we discuss some composite models of intervention that are recent and
deemed highly successful by observers.
3. Farmers’ empowerment program (Indonesia)
DDR is a pioneer in using Islamic philanthropic funds, such as, zakat, sadaqa and cash
waqf for alleviating poverty. The program for economic and social empowerment of
farmers by this leading non-government organization[17] in Indonesia seeks to provide
a solution to the multiple problems of limited land, declining soil fertility, high input
prices, limited capital, low and limited farming skills, unremunerative and fluctuating
crop prices. It has embarked on an organic farmers’ empowerment program called
Pemberdayaan Pertanian Sehat (P3S) that adopts a holistic approach involving
adjustment of cropping patterns and change in farmers’ attitude and preferences from
conventional farming to a semi-organic cultivation system. The intervention involves
gradual and continuous assistance, guidance and introduction to production facilities
that are safe, locally made and affordable, to biotech and low-chemicals system through
integrated and environment-friendly farming. The semi-organic cultivation system
reduces farmers’ permanent dependency on chemical agricultural inputs that are
expensive. With the user-friendly green agricultural technology, farmers can reduce
production costs while obtaining higher prices for the organic produce.
The organic farmers empowerment program (P3S) involves provision of farmland
on ijara (lease) and of capital for semi-organic farming with a view to bringing about
significant increase in farmers’ earnings. The empowerment process also involves
strengthening of farmers’ capacity as human resources and helping them get organized
as formal communities, called combined farmers groups (gapoktan). The intervention
ends when the combined farmers groups have developed the capacity to manage the
formal organization independently, putting in place partnerships with other
stakeholders to support the organization’s existence, and improved their bargaining
position in the market.
Farmers’ eligibility for P3S program is based on several criteria, e.g. income and
ownership, business potential and the farmers’ potential as human resources. The main
target group are poor farmers meeting the following criteria. The farmers’ family head
earns ⩽ two USD per day in rural areas, or ⩽three USD per day in sub urban areas.
The other criteria relate to condition of their house and ownership of assets. Approval
from local neighborhood based on the defined criteria is needed to confirm a poor
family’s eligibility for the program. The business potential criteria include: the
development potential, which reflects the ability to expand the business in scale and
scope, related to the raw materials availability, production capacity, market potency
and employment rate; the potential to create derivative businesses that allows more
employments and economic benefits for other beneficiaries; and the potential for local
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resources utilization. Besides the above, a farmer must be of minimum productive age
of 18 years or is married, with maximum age of 60 years; should have the vision for
developing business; should be able to work; and should not be enlisted as participant
of any other similar program.
3.1 Components of the program[18]
The empowerment program involves several stages. Stage 1 involves promoting
awareness or recognition of potential and the environment followed by building
comprehension that organization in the center-stage of this process must be started
with the community’s initiative through continuous strengthening of the organization.
The programs then aims to prepare a cadre of local farmers who would take over the
task of mentoring after the program ends; to provide technical support, associated to
the technical aspects of the production process, which includes the introduction and
implementation of organic farming technology and semi-organic farming, adaptation of
technology, development of pre-and post-harvest processes as well as access to
information. It seeks to assist the farmers in fulfilling their needs, both individually and
in groups, in a sustainable livelihood system. The overall objective is to maintain
a balance in the interests of all the stakeholders by enhancing the bargaining power of
farmers through their own cooperation-based institution.
The process of forming farmers’ organization involves the following stages. First,
individual farmers in groups of eight to ten form small groups. Next, several groups are
organized into a secondary group called a combined farmers’ group called gapoktan[19].
Finally, several gapoktans are combined to form the farmers’ cooperative.
Since a major problem for farmers is the lack of land ownership, one of the
components of the P3S program is the provision of leased land to farmers.
Once farmers groups are formed, the next stage is the leasing of land to each farmer at
an average land area of 25,000 m2 for each farmer or 2.5 hectares (six acres) for each
group. Farmers get lease land for one year with the rental fee of Rp 4,000.000 (USD 150)
per hectare per annum. In addition to the land lease package, farmers also receive
a package in the form of processing costs of land, direct costs of labor for one growing
season. Farmers are expected to use the organic agricultural inputs (saprotan) and
working capital funds of the enterprise. Labor fees are directly paid for the overall
processes of land production and harvest. Assistance is also provided in the form of
fertilizer, compost, plant pesticides, seeds, etc. The program through research has
developed its own organic agricultural input (saprotan) in the form of bio pesticide that
is local-based, affordable and environment friendly.
A major component of the empowerment program is institutional capacity-building.
Assistance for the strengthening of the institutional groups of farmers and farmer
groups (gapoktan) involves the following. Enhancing the capacity of farmers is done
through various forms of training in semi-organic agriculture as also in organizational
and financial management of farm groups and gapoktan administrators, establishment
of the gapoktan forum, as well as periodic monitoring and linking up to other
stakeholders and the market. For instance, during the process of cultivation of rice,
the tutoring process, both regular and irregular meetings, is done through visits to the
homes of the farmers. Tutoring is done through regular meetings of the Group once
a week. The process of transfer of appropriate technology and organic rice cultivation
is delivered through group meetings. An example of the move towards self-sufficiency
is a consensus made among farmers that each farmer must save up to 40 percent of
their harvest, which would initially be used to pay land lease for the following year.
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3.2 Zakat-funded programs
The organic farmers empowerment program (P3S) along with other economic
empowerment programs of DDR is funded with zakat. The funds dedicated to such
programs average about IDR 6.3 billion per year over the five-year period (2008-2012)
that hovers around 10 percent of total zakat resources available (see Table I). The low
dedication is attributable to apparent Shariah objections by some scholars who
emphasize on utilization of zakat for consumption alone in the short term. In the face of
a growing realization, however, that an emphasis on short-term may lead to a
dependency syndrome among the poor, and that the long term need of the poor is
economic and social self-reliance, DDR seeks to enhance the utilization of zakat for
community empowerment programs.
Among the major economic programs of DDR are: the masyarakat mandiri
(self-reliant communities), pertanian sehat (health/ organic farming), kampoeng
ternak nusantara (livestock development), Islamic microfinance (for-profit) in
addition to capacity building initiatives under Indonesia Magnificence Zakat. The
economic empowerment programs follow a similar model that involves interest-free
loan financing to groups from a pool created out of zakat funds. The key
distinguishing factor of this model is the phased building of self-reliant communities
and the creation of a community organization that would continue to provide
financing to the members.
The program has a clear termination and exit strategy. It withdraws from the region
and the program ends as soon as the community cadres are ready to take part in
maintaining program sustainability – financial and institutional. It ensures that a
community-based organization is a legal entity with adequate capacity to sustain
cooperation with all stakeholders. From a Shariah perspective, this ensures that the
“tamleek” condition of zakat is complied with, since the poor beneficiaries ultimately
become the owners of the local organization in a collective sense with transfer of assets
from the program to the local organization. Thus, the fact that they are borrowers in
the first instance does not appear to vitiate the “tamleek” requirement[20].
4. Credit and lease-based finance (Pakistan)
According to a survey by a group of researchers from Lahore University of Agriculture [21],
there are about 5.1 million farms in Pakistan. Of this, 93 percent are small and
marginal accounting for 60 percent of the total cultivated area. They also found that
about 70 percent of farmers participate in the credit market; a majority from
intermediaries charging exorbitant interest rates. Further, the farmers also believe that
they can save up to 25 percent in costs if they purchase inputs on cash. In addition,
given that farmers usually return the money after the sale of the crop, the study argues
that banks should participate in agricultural sector using bai salam as the mode of
No. Field program Program Funds (Rp billion) Beneficiaries
1. Organic farming 15 4.6 2,611
2. Livestock 9 6 997
3. Fisheries 52 11.1 6,175
4. For-profit microfinance 6 4.3 2,186
5. Research, in house and public training 150 5.6 5,164
Total 232 31.7 17,133
Table I.
Five-year details
on economic
empowerment
programs by DDR
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finance. A similar reasoning seems to underlie the design and development of salam
as an agri-finance product by Wasil Foundation, a leading Islamic microfinance
provider in Pakistan.
Wasil Foundation, formerly known as Centre for Women Co-Operative Development
(CWCD), is a not-for-profit company established in 1992. The aim of the organization is
to economically empower poor communities and assist them in developing their
businesses through micro credit and enterprise development programs. In 2009, Wasil
Foundation (formerly CWCD) extended its operations from conventional microfinance
to Islamic microfinance. Eventually, it discontinued conventional microfinance in 2010,
thus becoming a purely Islamic microfinance organization. The pioneering efforts of
Wasil Foundation in meeting the financing needs of different strata among the urban
and rural poor has resulted in a diverse range of products in its portfolio (see Table II).
Thus, Wasil has three products specifically targeted at the farming community. It
believes that farmers in Pakistan are traditionally skilled but lack capital. Its first
product based on bai salam is targeted at small farmers with up to five acre land
holding, who need money to grow their crops and to feed their families up to the time of
harvest. Under the salam agreement, Wasil makes payment of agreed price in advance
to the farmer against commitment to deliver agreed quantity of produce upon harvest.
It involves lower cost as compared to other alternatives and finance is provided against
a collateral in the shape of guarantee from community members or a charge on
available assets with the farmer, e.g. livestock. Wasil’s second product seeks to address
the issue of lack of land ownership among farmers through leasing. Wasil takes
agriculture land on ijara from the owners of the land in bulk and sub-leases the same to
farmers for agreed period in exchange of pre-determined monthly lease rentals. In case
of fruits/vegetable/flower farms the lease rental is paid in cash. In the case of wheat and
rice, the lease rental is paid in kind in the form of crops.
Wasil’s third product combines the concepts of ijara and salam and bases the whole
return on the principles of salam, which requires settlement of debt in terms of the
crops or produce. Under this agreement called Master salam, the farmer gets land on
rental plus cash as working capital to cover related costs and agrees to deliver a given
quantity of the crop to Wasil. A part of the repayment in terms of crop is towards
rentals on ijara while another part relates to salam. After the first cycle of finance, there
are two subsequent cycles of financing that are based on salam alone. After the two
additional salam cycles, the contract ends.
4.1 Risk factors and their mitigation
The main challenge concerning the salam transaction is the identification of the quality
of the crop and the determination of the price at which it must be procured. The
Government of Pakistan issues a support price for wheat at which the Food
Mode Target beneficiary
Zakat Destitute unable to work
Qard al-hasan Poorest of the poor with ability to work
Murabaha Micro level traders street hawker Small shopkeepers
Salam Small farmers up to 5 acre land holding
Ijara Farmers without land holding (rental land)
Diminishing Musharaka Micro entrepreneur in need of assets
Master Salam (Ijara + Salam) Developed by CWCD farmers in need of land plus money for cultivation
Table II.
Islamic finance
products by Wasil
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Department of Government of Pakistan procures it. However, when Wasil Foundation
approached these departments for the sale of crop, they refused due to the restriction
levied upon them by the Government of Pakistan whereby only a farmer may sell to
these departments. Thus, the only other options were the sale to the flourmills or to the
open market. Furthermore, unlike the support price at which the Government
purchases the crop, the flourmills and the open market rates are determined by certain
market factors including the quantity of national produce.
In order to determine the price, Wasil Foundation takes the data of the sale price in
a specific area over the last three years. This gives a rough estimate of what the price
is likely to be for the crop that is to be grown. Wasil Foundation then offers a float rate
at which the purchase price is negotiated with the farmer/client. This negotiation takes
place at the village level with groups of farmers who are likely to sell the crop to Wasil
Foundation. At the end of this negotiation, Wasil foundation determines a final price
at which it procures the crop. At times, this price may vary from area to area based on
the cost of production, the expected yield, the sale price of the area in the last years
and the amount of risk that the organization has to face.
In June of 2010, Wasil Foundation launched its first rice salam transaction. Unlike
wheat, the market rate of rice crop is entirely dependent on the quality of the crop
wherein the seed of the crop is of major importance. In the case of wheat, the seed being
planted does not directly affect the price, as the output crop is the same. In case of
rice crops, these are categorized in accordance to the seed that is being planted by the
farmer. Thus, the challenge of the quality of the crop and the proper identification
of the seed is of vital importance while conducting a salam transaction on rice. For
this, Wasil Foundation trained its procurement and sales department, through the
agriculture department of Government of Punjab, Pakistan, on the types of rice and
the identification techniques of rice.
Unlike wheat, there is no support price by the Government for rice, which makes
the estimation of the purchase price more complex for rice. The options open for
Wasil Foundation are again, as in the case of wheat, the selling of the crop to the open
market or the rice mills in the area. However, unlike wheat, when rice is harvested, it
contains a high moisture content due to which the total weight of rice is increased
by approximately 15-20 percent. This moisture further induces a chance for the crop
to be damaged if it is not dried up in time. These issues increase the risk of holding rice
at a warehouse for collection and sales purposes. Thus, unlike wheat, which may be
stored for up to three months by Wasil Foundation, rice is to be sold within a maximum
of one-month period due to the unavailability of the proper infrastructure to store rice.
This challenge still exists while conducting a rice transaction of salam.
The crux of the Master-salam product is the repayment in the form of crop rather
than cash. This makes enormous sense, given that the client/farmer is not rich in cash
during his crop cycles, which makes it difficult for the farmer to make the monthly
repayment in cash. However, the farmer/client is rich in crop at the time of harvesting.
Therefore, the product is focused on the principles of salam wherein the crop is delivered
as a repayment for cash inputs, plus for the extra input of land in the form of ijara.
5. Composite partnerships with farmers (Sudan)
A model that has been experimented in Sudan in the recent past adopts a composite
finance-plus approach to support the farming communities.While there are elements of
credit-based financing, the overall models are rooted in partnership. The underlying
rationale for this approach seems to be the pivotal role that the IsFIs see for themselves
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in addressing various problems of the poor farmers and in enhancing food security of
the region. While agriculture in Sudan faces problems similar to those in Indonesia
and Pakistan, the challenges here are even greater arising out of adverse weather
conditions, large tracts of drought-affected land and civil strife leading to a faltering
economy riddled with unemployment. Islamic microfinance in Sudan, however, has a
lot to offer in terms of its uniqueness and high success rate.
The microfinance program of BoK, known as IRADA, is experimenting with new
and innovative models of intervention to make inroads on chronic social problems, such
as, poverty and unemployment. As part of the Sudanese economic system, it operates as
a Shariah compliant bank. At the same time, it uses participatory modes within a model
that is rooted in cooperation to create and share wealth in the agriculture sector[22].
BoK was established in 2002 while its microfinance program (IRADA) was established
in 2009 with the support and assistance from the Islamic Development Bank. The
department was given the mandate to implement the SDG 200 million Al-Aman fund
for microfinance. The fund was formed by a strategic partnership between the Diwan
Zakah (apex body of zakat management in Sudan) and 32 Sudanese commercial banks.
IRADA was set up with a vision “to alleviate poverty and hunger by realizing the
potential of the poor through development of limited resources and affordable
financial facilities,” and a mission “to increase the numbers of poor people involved in
entrepreneurial activities through Islamic finance and expanding income generating
activities, creating sustainable livelihood and employment.” Its programs and
activities are influenced by its strategic approach theme, which states, “Today the poor
are our clients, but tomorrow they will be our business partners.” Since inception,
IRADA identified and focused on “economic empowerment through group finance
and partnership.”
5.1 Innovative use of zakat
In perhaps the first documented example of utilization of zakat for gharimeen (indebted)
in an organized manner, globally speaking, a security portfolio was created through a
partnership between the Diwan Zakah (apex body for zakat management in Sudan) and
commercial banks. The portfolio has a capital of 200 million pounds with 25 percent
contributed by the former and the balance by the banks. The portfolio provides an
insurance to the program against genuine defaults by clients at the second level. At the
first level, the default is covered by individual personal guarantor(s) brought in by the
client. The portfolio covers all productive sectors (commercial, agricultural and
vocational) across Sudan.
5.2 Business development services
IRADA has carefully developed a network of providers of business development
services on its payroll to provide a range of additional services to its clients. In many
ways, these officers are key to the overall success of the program with their ability to
source and procure the assets needed for the income-generating microenterprises and
their role in monitoring the clients. In fact, each client is assigned a business
development officer who is responsible for ensuring that the relevant asset is delivered
to client, that the supplier is paid, and that the client makes timely repayment to the
bank. The business development officers are also entrusted with the task of advising
the clients on how their business can be more profitable. They also use their network in
order to facilitate mutual exchange among their clients. The provision of business
development service is adequately incentivized.
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5.3 Abu-Halima Greenhouses Project
The Abu-Halima Greenhouses Project of IRADA, designed in 2011, uses a composite
model of intervention that combines several “smart” factors and is designed to address
several critical social issues including lack of food security, unemployment and
poverty. It aims to open new economic opportunities for young university graduates
with formal education in agriculture. The project in its current phase, targets economic
empowerment of 125 educated unemployed graduates and their families. The project
involves setting up 25 productive units of greenhouses with annual capacity
production of 1,200 tons of off-season vegetables using latest technology in the
industry and professional expertise using the partnership-based mode.
The business plan of the project is rooted in the economic peculiarities of the local
market for vegetables, which witnesses a major spurt in the vegetable prices because
of adverse weather conditions. The greenhouses would enable the micro-entrepreneurs
to grow high-value vegetables all through the year, while smoothening the supply
of vegetables in the Khartoum market. The greenhouses can now grow vegetables that
usually witness many-fold price rise during summer and other high-value vegetables
during winter, thus, reducing price volatility. The underlying model for the project
is presented in Figure 2.
The model (restricted mudaraba partnership). Unlike the regular micro-credit
products, or even the commercial mudaraba products, the partnership between the
bank and the micro-entrepreneurs extends well beyond that of a creditor and debtor or
that of a rabb-al-maal (fund provider) and mudarib (fund manager). The bank assumes
Min. of Finance IRADA – BoK
Abu Halima
Min. of Social Affairs Graduates
Min. of Agriculture
Tech Consultant
Sana Hypermarket
1
2
3
5
7
6
8
9
10
4
Notes: Arrows denote specific activities as follows: (1) financial partnership
between Ministry of Finance and BoK; (2) nomination of agriculture graduates for
the project by Ministry of Social Affairs; (3) Mudaraba agreement between
IRADA (BoK) and the micro entrepreneurs (agriculture graduates); (4) setting up
of Abu Halima greenhouses; (5) technical consultancy to micro entrepreneurs;
(6) technical consultancy to greenhouse establishment and operation;
(7) provision of fertilizers and other services by Ministry of Agriculture; (8) sale
of vegetables output to Sana Hypermarket and others; (9) sharing of profits
(40 percent for five years and 100 percent after that) by micro entrepreneurs; and
(10) sharing of profits (60 percent) by IRADA-BoK for five years
Figure 2.
The Abu Halima
Project
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responsibility for provision of financial as well as a range of non-financial services to
the micro-entrepreneur in the form of technical, marketing and business development
services. The latter involves direct investment in creation of assets for supply of
electricity, water as well as for vegetable cooling, storage and other services.
A beneficiary of this project must come from low-income strata of the Sudanese
society and the income of the household should not exceed two times the minimum wage
of USD 207 per month according to the law of Central Bank of Sudan. The beneficiaries
are organized into jointly liable groups of households (headed by graduates, preferably in
agriculture) in the form of a cooperative society registered according to the Sudanese
Cooperative Law. These groups enter into the restricted mudaraba partnership contract
with BoK. The micro-entrepreneurs receive the required technical training from experts,
managerial and marketing support from the bank. They are eventually organized into a
co-operative, which allows them to benefit from common facilities while retaining their
right to do business activities.
Other stakeholders and partners in the project include: Ministry of Finance, which has
made a social contribution of 6.5 percent of capital; the State Ministry of Agriculture,
which helps get fertilizers and assists in technical capacity building; the Ministry of
Social Affairs, which nominates the beneficiaries through its Graduate Fund; and Sanaa
food hypermart and home center – a major supermarket chain – which has committed to
off-take the vegetables. A technical Turkish firm, specializing in the technical aspects of
greenhouse projects is a significant contributor to the success of the project.
Financing method. The financing product is structured using the mudaraba mode
with profit and loss features. Losses would be absorbed by the bank while profits
would be shared in the ratio of 40 percent for the micro-entrepreneur and 60 percent for
the bank. Profit distribution would take place twice in a year. The “restricted”
mudaraba involves total financing to the tune of SDG 15 million (USD 4.50 million),
which accounts for about 6 percent of the total portfolio of IRADA. It involves
financing of working capital to purchase the 25 greenhouses, supporting infrastructure,
technical feasibility, technical capacity building, agricultural inputs and living
allowances. As stated above, the Ministry of Finance has contributed 6.5 percent of
mudaraba capital as a social contribution with a view to lower the costs borne by the
beneficiaries.
IRADA’s product package includes the services of an administrative coordinator,
and an agricultural expert to supervise the production process and technical matters,
ensure quality control and providing training. Such costs are included with the direct
cost of the product. IRADA would retain control of the venture for five years,
essentially to ensure its profitable operation. During this implementation period of five
years, the graduate micro-entrepreneurs would be trained to manage the ventures.
IRADA would cede control of the project assets to the cooperative as a gift or sale at a
nominal price after five years. Depreciation of assets is calculated at 20 percent per year
over five years. The only collateral that the bank would be seeking for this financing is
a personal guarantee against mismanagement and lack of commitment. There are no
financial or physical collaterals required. However, the households, through the
cooperative society, are required to submit a check as a security for default and
infringement. The title of the assets is in the name of BoK as the rab-al-mal during the
finance term, thereby, mitigating the asset-related risks. BoK, being the provider of the
funds (rab al mal ), has an insurance contract with the Islamic Insurance Company to
cover the assets against any loss.
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The returns on investment to IRADA would come in the form of 60 percent of
profits made on the sale of 1,200 tons of high value vegetables and fruits annually. This
is expected to generate an ROA of 18 percent and IRR of 22 percent for the bank.
Returns to the micro entrepreneurs would come in the form of balance profit share,
estimated at SDG 2,100 per family plus an additional living allowance of SDG 300-600
per family during the implementation period. The returns are expected to significantly
increase to SDG 7,000 per family, since IRADA would withdraw after this period and
the micro entrepreneur would receive full profit share.
A unique feature of the design of this microfinance model is the safety net during the
implementation period of five years. This makes enormous sense as the mudaraba
profits may display volatility while the basic needs of the micro entrepreneurs must be
taken care of on a priority basis.
Non-financing services. Another unique feature of this project is the magnitude and
variety in the provision of a multitude of non-financing intervention/ services to the
micro entrepreneurs. These may be listed as under: assistance to source and hire
technical firm to construct greenhouses and related infrastructure and to provide
technical support throughout project lifetime; pre-production support in the form of
seeds, fertilizers, pesticides, machineries, electric and water sources; at-production
support in the form of living expenses allowance, operational expenses, harvest
expenses, technical support; after-production support in the form of cooling storage
and grading room; assistance to source large customers such as DAL and Home Centre
to purchase produce; assistance to manage the project accounts; formation and
registration of cooperative of farmers; and transfer of ownership to the cooperative
upon its readiness to manage the business.
Risk management. An agri-venture like Abu Halima faces several risk factors,
many of which may lead to crop failure and consequently to failure of the project.
The success of the project hinges on mitigating these risks. Below we list some
major risk factors identified by BoK and the various measures contemplated to
address them:
• Inability to sell produce: contractual agreement with major customer(s) is in place
to purchase products at market price.
• Crop failure due to disease: program has provided the micro entrepreneurs
with fertilizers and ensured that they have the capacity to use appropriate
amounts.
• Crop failure due to heat: greenhouses have automatic temperature control.
• Crop failure due to lack of humidity: greenhouses have automatic humidity
control.
• Crop failure due to lack of water: drip irrigation system is developed to provide
water. Well is constructed to provide sufficient water.
• Electricity blackouts: program has provided generators that run on diesel to
function as backup electricity.
• Unmet consumption needs leading to a lack of commitment: families are provided
SDG 300-SDG 600 as living allowance every month all through the five-year
implementation period.
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• Lack of commitment by beneficiaries: BoK has retained an option to remove a
given beneficiary and replace them with another. Beneficiaries have to sign into
work and their performance is monitored. Bank has the prerogative to distribute
a larger proportion of profits based on performance and commitment.
• Conflict during distribution of profits due to different yields: profits of the micro
entrepreneurs and bank is based on the total production of all the greenhouses
and not on an individual greenhouse basis.
Challenges. Notwithstanding the apparent success of the model, several challenges
remain. The first set of challenges relates to the beneficiaries. First and foremost, the
project assumes that the beneficiaries come with the qualities and characteristics of a
micro-entrepreneur, especially when it relates to the agriculture sector. This is a strong
assumption. Many of the beneficiary-entrepreneurs may turn out to be deficient in
terms of their abilities, notwithstanding the training and capacity building inputs
provided to them. Behavioral traits, such as, indolence, apathy, negligence and
impatience are hard to change. To get over their deficiencies, several farming tasks are
outsourced and the cost is charged to the beneficiaries according to mudaraba rules.
Further, lack of financial acumen on the part of the beneficiaries is likely to deter a
proper understanding of the mudaraba contract and its implications in terms of rights
and obligations of the parties. The second set of challenges is institutional. Compared to
traditional banking and microfinance products, micro-mudaraba is a new financing
methodology that requires developing much of the procedures and mechanisms de
novo. At the same time, these are likely to be more complex, especially when these
involve multitude partners. The third set of challenges come from a lack of an enabling
environment, such as, weak mudaraba laws. A major challenge may be in the nature of
political interventions that send a wrong signal about the product being noncommercial.
Macroeconomic developments, such as, high inflation rates may also
wreak havoc on financial estimates.
5.4 Wad-Balal livestock development
Livestock production is an important component of the local economy in Sudan,
providing food, employment, foreign exchange earnings, a source of wealth, and supply
of inputs and services, such as draught power, manure and transport. The livestock
subsector however, faces numerous constraints, including a heavy disease burden, low
productivity exacerbated by drought and insecurity, the lack of adequate marketing
infrastructure, and poorly organized and informed livestock owners and traders. The
Wad Balal cattle fattening project of IRADA involving an investment of SDG 9.30
million (about USD 1.68 million) aims to curb poverty by addressing many of the above
problems. The project aims to produce 7,000 cattle annually meeting export standards,
link the poor livestock herders with international markets utilizing contacts of the
Sudanese diaspora and increase incomes of an estimated 250-300 poor families. The
model underlying the project is presented in Figure 3.
The model. The model of intervention involves three parties – IRADA of BoK; the
Wad Balal Company owned by a group of Sudanese diaspora in the GCC; and the Wad
Balal Association with cattle farmers as members. Under the arrangement, IRADA will
have a diminishing musharaka agreement with the Wad Balal Company to invest in the
required physical assets and create a facility for fattening of the calves. The Company
will provide the technical services for the project. The Musharaka will provide the
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facility/assets on ijara or lease to the Association comprising the farmers. IRADA and
the Company will share the lease rentals from the farmers, as received by the
Musharaka. The latter will buy out the share of the former over a period of five years
by using a share of its profits. Further, a pre-agreed share of the profits of the Company
would be used to provide social benefits to the local community. The Association will
sell all the cattle post-fattening to the Company, which will ensure quality standards
and export the same to international markets. At another level, IRADA will provide
murabaha financing for purchase of calves to the Association. Murabaha financing in
bulk reduces the cost of purchasing calves. The project, by facilitating the production
of 7,000 export quality cattle every year and, by linking the farmers to the international
markets, enhances incomes of 250-300 poor families.
Financing method. The musharaka between IRADA and Wad Balal Company
was formed with 95 percent of capital contributed by the former (amounting to SDG
5.04 million) and 5 percent by the latter. The musharaka would make direct
investments in hangers, electric sources, water sources, and fattening supportive
investment that include cooling storage, services facilities, securities facilities, living
allowance of beneficiaries and technical support. The financing tenure is five years.
The lease of the cattle fattening facility to the association would bring in rentals at
18 percent per annum on ijara of assets used for cattle fattening to the association.
The revenues from ijara is shared between Wad Balal Company and BoK as per the
agreed terms of diminishing musharaka. The murabaha financing amounting to SDG
4.26 million will involve murabaha to purchase calves for Wad Balal Association at
IRADA – BoK Wad Balal Company
Fattening
Wad Balal Facility
Association
Farmers
Tech Consultant (WBC)
3
1
2
6
7
4
5
OVERSEAS MARKET
8
Notes: Arrows denote specific activities as follows: (1) diminishing Musharaka
agreement between BoK and Wad Balal Company (WBC) to create fattening
facility; (2) Bok helps farmers form Wad Balal Association (WBA); (3) Murabaha
agreement between BoK and farmers represented by WBA to finance purchase of
calves; (4) Ijara agreement between Musharaka and WBA to use facility in lieu of
payment of rentals; (5) use of fattening facility by farmers to make the calves
grow; (6) technical consultancy and training by WBC; (7) delivery of cattle by
farmers to WBC; and (8) sale of cattle by WBC in overseas markets
Figure 3.
The Wad Balal
Project
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15 percent profit margin. BoK will provide 100 percent financing for calves in the first
two years; which will gradually reduce to 25 percent in the fifth year.
Non-financing services. As before, this initiative also involves a multitude of nonfinancing
intervention/services that include the following: technical support throughout
project lifetime to ensure production quality and cattle vet services, establishing linkage
with Wad Balal Company with access to market in GCC countries, assistance in
managing the project accounts, and formation of Wad Balal Association of farmers.
Risk management. An agri-venture like Wad Balal faces several risk factors,
many of which relate to the marketability of the cattle that are reared by the farmers.
The success of the project hinges on mitigating these risks to acceptable minimum.
Below we list some major risk factors identified by BoK and the various measures
to address them:
• Diseases: the project provides on-site veterinarian services to treat and prevent
cattle diseases.
• Lack of quality and specifications (e.g. health, weight) for export market: on-site
technical services are provided to educate farmers how to raise the quality of
their livestock and meet international standards.
• Unmet basic needs of farmers: families are provided living allowance.
• Inability to market: the Wad Balal Company, which has strong export, links with
the GCC countries have committed to purchase the cattle at a fair price.
• Lack of commitment by farmers: this risk is mitigated considerably by retaining
the right with BoK to remove a shirking beneficiary and replace with another
committed worker. This is backed by stringent performance monitoring. Good
performance is also incentivized with BoK having the right to distribute a larger
proportion of profits based on performance and commitment. Performance of
individual farmers is also monitored at the Association level.
5.5 Building strategic food reserve
Under another program involving multiple partners, IRADA microfinance aims to
purchase goods efficiently from farmers for sale to the Government of Sudan’s strategic
food reserve. This would replace the intermediary and ensure a better price for farmers
for their produce based on official advance purchase rates determined by the Ministry
of Agriculture. This ensures that the farmers’ incomes increase and more farmers are
motivated to produce for livelihood in addition to subsistence. The other partners in
this program are the Ministry of Agriculture and the Ministry of Social Welfare of the
government of Sudan, the Zakah Chamber of Sudan and the World Food Program.
Under this program, IRADA provides salam financing with a tenure of a maximum
of eight months. Its target beneficiaries include 73,000 smallholders under 878 Farmers
Association in seven states (23,677 through direct contract, and 48,396 through
mudaraba with other commercial banks). The program involves multiple parties in a
multitude of roles. IRADA serves as the link between the farmers and other partners
and in grouping the farmers into associations. The Ministry of Agriculture provides
technical assistance for product quality and building the capacity of farmers groups.
The World Food Program provides food for farmers during the planting period.
Finally, IRADA provides for coordination and monitoring of partners activities and
links farmers to local, regional and global markets.
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6. Lessons and way forward
Agricultural growth has a direct impact on poverty by raising farm incomes. It indirectly
impacts poverty through generating employment and reducing food prices. When
centered on smallholder farmers, it requires creative and innovative interventions that
involve provision of a range of financial and non-financial services to them. The latter
include technical skill enhancement of the farmers as well as their empowerment through
producer organizations. This paper undertakes a review of a range of interventions
that have been undertaken in recent years to achieve the same in the Islamic framework.
An alternative approach has been attempted in these experiments. This is based on the
argument that the conventional products and services may not be acceptable to farmer
communities in the Islamic societies, since these violate some fundamental religious
and cultural norms. The key lessons from the case studies included in the paper are
highlighted below.
The conventional lending methodology for the rural poor is rejected in the Islamic
framework on a fundamental ground. Islam prohibits any gain or price for credit.
It does not permit any increase in the quantum of debt due to what we know as the
“compounding of interest.” Thus, while Islamic finance includes products that create
debt, it curbs automatic expansion of credit. Given that the clients come from the
poorest strata of the society, there is merit in a more “humane” form of credit that rules
out penalties for genuine delays in repayment. The paper presents the case of IsMFIs
offering bai muajjal, murabaha, ijara, bai salam where the quantum of debt obligation,
once created and determined, is not permitted to take any other value due to its
restructuring. Nor are penalties a source of income for them.
A review of various Islamic modes that are used for provision of finance to farmers
reveals that there is no one-size-fits-all mode, even though bai salam is widely seen to
be the appropriate mode for agricultural finance. Further, Shariah-compliance of a
mode does not by itself ensure freedom from exploitation. As the examples show,
salam can often involve exploitation when the advance price paid to the poor farmer
is artificially pegged at low levels due to his/her weak bargaining power. Identifying
appropriate organizational structure, e.g. a farmer’s cooperative, may replace the
vendor and thus prevent exploitation of individual farmers by the latter. Similarly,
rates on murabaha and ijara financing can be and often are exploitatively high.
In case of participatory modes e.g. mudaraba, musharaka and muzara’a the sharing
ratio could be unfairly biased against the poor beneficiary because of their low
bargaining power. Prudential regulation of markets is an important pre-condition to
ensure healthy and adequate competition among the players and thereby, remove
abnormal and/or illegal profits through mispricing. Of course, these “exploitation”
concerns apply to for-profit modes only and call for a greater reliance on not-for-profit
modes of microfinance.
Islamic finance discourages debt based products and encourages equity and
partnership based products in general. Given that conventional MFIs derive their
income from interest, they seem to be inclined to push their clients into larger and
larger amounts of debt. In the Islamic approach, debt is not just discouraged; there are
built-in mechanisms, such as zakat to address over-indebtedness of an individual.
The paper documents the cases in Sudan where an institutional mechanism exists for
use of zakat for curbing indebtedness.
Islamic finance requires “simplicity” in contracts where the rights and obligations
of the parties are well understood by them. Even where an Islamic finance model
includes future obligations, or composite structures, the uncertainty and ambiguity
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factor is kept to the minimum. The diminishing musharaka based models used in
Sudan are apparently complex but quite “definitive” in terms of transfer of ownership
of the key assets into the hands of farmers over a finite period.
While credit and finance are key inputs for transforming the lives of the farmers,
they often require a wide range of non-financial services. Identifying these nonfinancial
needs and finding creative and innovative solutions thereto is critical for
success of any intervention. The paper documents a range of such services provided in
Indonesia, Guinea and Sudan in particular including: technical assistance, skill
enhancement, procurement, production, warehousing, processing, packaging and
marketing support that underlies the success of these interventions.
A related question is how these non-financial services are to be funded. Should they
be priced? Should the farmers pay for these services? The cases documented in this
paper highlight both commercial and philanthropic approaches to the issue. While in
the Sudanese examples, the costs are duly accounted for in the determination of profitshare
for the farmers, the Indonesian experiment provides a zakat-funded approch.
Indeed the inter-mix of philanthropy with a commercial approach is a key feature of the
case studies discussed in this paper.
MFIs that focus on financing the need for physical assets by farmers through
conventional or Islamic credit, or through leasing often ignore the importance of
providing for basic consumption needs. It should not come as a surprise if farmers
resort to diversion of funds from the so-called income-generating project or even
distress sale of the assets (funded by MFIs) if the basic consumption needs remain
unfulfilled. Indeed, in case of the Sudanese projects the provision of safety net by
IRADA is perhaps a significant contributor to the success of the projects.
Community-driven development (CDD) is a recent experiment in poverty alleviation.
Despite the success of this approach, a major constraint with conventional CDD is the
recurring nature of funding requirement while recurring grants may not be
forthcoming. This paper documents a case in Indonesia where zakat is used to fund
subsequent phases of CDD. The Islamic CDD is free from the constraints facing its
conventional counterparts, given that zakat is an annual recurring flow unlike the
conventional grants that may be one-time or erratic at best.
The projects discussed in this paper not only seek to leverage existing skills,
but also develop new skills. Specifically, the Indonesian and Sudanese
interventions seek to take the technical skills of farmers to a completely new level,
which should enable them to create wealth by applying better farming technology on
a sustained basis. The Sudanese projects in particular use an approach similar to
conventional venture capital funding (with some differences, of course) and focus
on the economic viability of project. They carefully seek to identify risks and
mitigate them. They also provide a unique example of combining benevolence with
commercial viability.
To summarize, the case studies presented in this paper provide insights into the
alternative modes and models of Islamic microfinance that are in use to provide
livelihoods, socially and economically empower the farming communities, enhance
food security and alleviate poverty. The need for these solutions arises due to possible
self-exclusion of farmers from conventional microfinance on the ground of their
incompatibility with religious beliefs. The models and tools of Islamic microfinance
display major variations as they seek to provide financial and non-financial support to
the farming communities. While some IsMFIs focus on the provision of micro-credit
to farmers, following an approach similar to that of conventional agri-finance
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and microfinance institutions while ensuring Shariah-compliance of their credit
product(s), a few others prefer a more comprehensive and challenging approach.
The latter group of IsMFIs assume that an MFI must play the role of a pivot in
a process of transformation, and in the economic and social empowerment of the
farming communities. These IsMFIs adopt a “project” approach and provide support in
a multitude of areas other than finance, such as, technology, procurement, production,
marketing, business development, capacity building, and thus, ultimately steering
the project to success.
However, in confronting the multitude of challenges facing the farming
communities, the MFIs may have to limit their outreach significantly. While in case
of credit-based finance, the size of financing per beneficiary is very small, perhaps in
the range of USD 100, the same is very high in case of project-based approaches that
seek to finance the entire value chain. Such partnership-based agri-finance may require
large upstream investments; perhaps placing them in a distinct category of social
impact investment and not in that of microfinance. For instance, the size of financing
per beneficiary is capped at USD 32,000 in case of Abu Halima Green Houses project.
No wonder, while salam-based microfinance by IRADA directly targets over 23,000
farmers, Abu Halima targets a meager 125 agriculture graduates. This naturally raises
the question: Is salam financing the best that Islamic finance can offer in the field of
agriculture? At the same time, it is important to note that projects like Abu Halima
and Wad Balal may have a far more significant long-term impact in terms of
building capacities of farmers as also in enhancing food security. Such projects
help create a new generation of technically superior and highly skilled farmers
increasing the supply of and stabilizing prices of high-value foods. Further replications
of such projects would also bring down the marginal costs. Another unexplored
possibility in Islamic finance is the establishment of awqaf or endowments to take
care of the upstream investments that create permanent or long-lasting facilities for use
of farmers. Such investments need not be funded with bank finance. If so, the quantum
of financing per beneficiary will significantly go down and the outreach of IsMFI may
be significantly increased.
Another interesting dimension of the Abu Halima and Wad Balal projects is the
contribution of grant money by the Ministry of Finance to the Mudaraba, which makes
it possible to offer murabaha financing at a modest rate of fifteen percent. Given the
widely expressed concern about affordability of high-cost microfinance, such a
possibility offers great promise. In a modified model, the Ministry may easily be
replaced with a dedicated waqf, which can pave the way for affordable microfinance for
the poor.
A unique dimension of the Wad Balal project is the fact that a pre-agreed share of
the profits of the Wad Balal company (that serves as the pivot in the structure and
would be eventually owned entirely by the Sudanese diaspora) would be used to
provide social benefits. One may draw a line of comparison between such a corporate
entity and a waqf, which dedicates a certain percentage of its profits for provision of
specific social benefits. Indeed, with minor variations, the two project structures could
easily fit in new situations and find acceptance in a variety of countries and regions. In
the Sudanese scenario, several ministries of the government contribute significantly to
the success of the projects. The active involvement of the ministries of the government
in other countries may give rise to apprehensions and concerns about coordination and
efficiency. As an alternative, the substitution of the institution of waqf for government
may be explored.
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Notes
1. Together, these three countries account for over 440 million of the world Muslim population
(see Central Intelligence Agency, 2014).
2. Food and Agriculture Organization (2013).
3. Pakistan Economic Survey (2014).
4. World Bank (2003) defines smallholders as those with a low asset base, operating less than
two hectares of cropland.
5. The 1970 Unregistered Land Act ensured that any land, occupied or unoccupied, which had not
been registered before the commencement of the Act would be the property of the government.
6. US Country Studies, Library of Congress (1991); also Zaroug (2000).
7. Busschaert (2014) discusses the concept of microfinance for agriculture investment in small farms
(MF4SHF) and presents the mechanism to create high and long-term impact in small farms.
8. For a comprehensive discussion on the Shariah-compliant modes of microfinance, see
Obaidullah (2008a, pp. 55-64).
9. Riba and Gharar being Arabic terms can only be loosely translated. Riba is translated as “excess”
or “growth” and generally implies usury. Gharar is translated variously as “uncertainty”, “risk” and
“ambiguity”. For a comprehensive definition of riba and gharar, see Obaidullah (2005, pp. 21-35).
10. For a comprehensive analysis of istijrar and its possible applications, see Obaidullah (2005,
pp. 190-192).
11. The Grameen model is the text-book model of conventional microfinance that uses jointliability
and group financing as a substitute of collateral in mitigating high credit risk with
the rural poor.
12. For example, neither the price of a cow and a goat are same, nor can one buy, say, one and
half goats for a pre-determined amount of funding. For a case study of RDS, see Obaidullah
(2008b, pp. 14-43) and for a more recent version, Obaidullah and Shirazi (2014, pp. 88-94).
13. See Obaidullah (2014).
14. See Obaidullah and Saleem (2011, pp. 206-216).
15. For a discussion of the Iranian Qard al-Hasan Funds, see Obaidullah (2008a, pp. 37-38).
16. For a case study of Akhuwat see Obaidullah and Shirazi (2014, pp. 81-88).
17. For a comprehensive report on the programs of DDR, see Obaidullah et al. (2014, pp. 66-69)
and Alim (2014).
18. For further details on this program, see Mintarti (2013) and Alim (2014).
19. Gapoktan is a term in Bahasa Indonesian language that refers to small groups.
20. The Arabic term “tamleek” translates into “imparting ownership”, which is an essential
condition for zakat distribution to any beneficiary. For more on this issue, see Obaidullah
(2013, pp. 60-61).
21. See Kaleem and Abdulwajid (2009, pp. 275-292). The estimated percentage of small farms is
larger as compared to the IFPRI (2005) estimate cited earlier.
22. Not surprisingly therefore, it was adjudged to be among the top three participants (Wasil
receiving the top award) at the Global Islamic Microfinance Challenge 2014 organized by the
CGAP (Consultative Group to Assist the Poor), the Islamic Development Bank, Al Baraka
Banking Group and Triple Jump, which evaluated innovative Islamic microfinance
experiments with a focus on product development.
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Corresponding author
Dr Mohammed Obaidullah can be contacted at: [email protected]
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